Tag: private equity

Michael Lindauer, Allianz Capital Partners

Fund Shack
Fund Shack
Michael Lindauer, Allianz Capital Partners
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Michael Lindauer is co-CIO of Allianz Capital Partners. He joined the institution in 2003 and has been an influential decision-maker with regards to backing private equity managers, and a respected and informed LP. He is based in Europe and has responsibility for ACP’s global private equity investment programme.

He talks to Ross Butler of Linear B Group about Allianz’s investment business and market-view, approach to GP selection and terms, and much more. This is a must-watch conversation for any private equity manager who wishes to understand how an experienced and thoughtful institutional investor approaches fund investment opportunities.

Jim Strang, private markets – the inside track

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Fund Shack
Jim Strang, private markets - the inside track
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Jim Strang is chairman of HgCapital Trust, a senior adviser to CVC Capital Partners, independent director at the Business Growth Fund, a senior adviser at Bain & Company, an advisory director at Campbell Lutyens, a Fellow at the London Business School, and a senior adviser at Hamilton Lane.

Back by popular demand, this is Jim’s second time on Fund Shack. We talk about the state of private markets and how the industry grows from here.

David Ewing, ECI Partners

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Fund Shack
David Ewing, ECI Partners
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David joined ECI Partners, one of the UK’s oldest buyout funds, in 2001 and is now co-managing partner. He started out in software and has completed several landmark deals, including the UK’s first buyout of a native digital business and the UK’s first buyout of a native SaaS business.

We talk about software investment, the UK’s competitive edge, originating deals in the mid-market, expanding internationally, and the prospect for private equity returns.

Mirja Lehmler-Brown, Hayfin

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Fund Shack
Mirja Lehmler-Brown, Hayfin
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Mirja Lehmler-Brown is the founding managing director of Hayfin Capital Management‘s Private Equity Solutions investment team.

She previously worked with Hayfin founder Tim Flynn (listen to his Fund Shack podcast here) at Goldman Sachs, before moving into PE fund investment with Aberdeen Asset Management and Scottish Widows.

Ross Butler (00:00):

You’re listening to Fund Shack. I’m Ross Butler. And today I’m speaking with Mirja Brown, a managing director with Haven capital management. Mirja started out in investment banking with Goldman Sachs and then worked in asset management with Scottish widows and Aberdeen. She joined Hayfin to establish and build its private equity solutions business. We talk about setting up and growing an investment function from the ground up manager selection, direct secondaries, and investment opportunities across Europe. Welcome to fund shack. You joined Hayfin in 2018. I think that’s correct. Tell me, how did you get involved with it

 Mirja Lehmler-Brown (00:38):

Started quite a long time ago, Tim Flinn, our CEO, and founder worked at Goldman Sachs.

Ross Butler (00:45):

Who we’ve had on Fund Shack 

Mirja Lehmer-Brown (00:46):

Yes, and we work together at leverage finance. In fact, we’re sitting next to each other and I left, Goldman Sachs to move, up to Scotland. My husband is Scottish, but we stayed in touch over the years. And so I, heard the story evolve from him leaving and then coming up with the idea to set up, HayFin. And, you know, we exchange ideas and views and, and shared learnings up in Scotland. I started to invest in private equity with Scottish widows initially. And that experience from an LP perspective was also interesting, you know, to Tim when we started out. So when he sat up, he, had discussions with a few different private equity funds and he asked my views on who they were and what potentially could be a good partner for him early doors. So, that then turned into him growing, uh, or him and his team growing the business.

 Mirja Lehmer-Brown (01:47):

And in 2070 that institutional investor changed to British Columbia investment management corporation. And he’d grown the business from lending and other different products within the credit space and never, ever kind of, I guess, before considered the equity, opportunity. And that’s where I then spent over 10 years up in Scotland. And, so he asked me if I would want to, what would I do if I would set up a private equity mid-market business for, British Columbia? How would that look? And would I be willing to do that on his platform? So I did that and come up hopefully with a compelling strategy because British Columbia certainly thought it was a good idea. And that’s why I moved over in 2018 to start from scratch with, with no team, no processes, but a fabulous platform and brand in form of Hayfin.

Ross Butler (02:49):

So that sounds like a great opportunity, but, quite an unusual one, because you had a very large institutional background. So you sat next to Tim and you were doing presumably were doing credits at the time, is that correct?

Mirja Lehmer-Brown (03:00):

Correct? Yes. So Goldman Sachs, but from Scottish widows. So when I started, there was only private equity, only Europe, predominantly mid-market and across the spectrum from funds investing from co-investing and also secondary investing, which is three of the larger group of investing that you can do in the private equity market as an LP investor.

Ross Butler (03:24):

So why did this kind of more entrepreneurial opportunity of setting something up from scratch appeal to you?

Mirja Lehmer-Brown (03:29):

Very good question. I come from the middle of nowhere, in Sweden and I’m actually the first person in my family to go to university. So arrogance and Politics are something that I can say I’m allergic to. And in a large institution, I think when you start out working you’re so focused on delivering a good job that you don’t notice political aspects. I think as you grow older, more experience wiser, you start to figure out that it’s not just about that delivering. It’s not just about the excellent, it’s lots of other things going on as well. And at that point, after 10 years in a consolidating Scottish asset management market, it’s been a number of combinations that we had gone through much larger group and, the firm had become very political and that again is something that’s really frustrating. And I also just in itself, for me, I’m driven by delivering really good investment return based on facts.

Mirja Lehmer-Brown(04:35):

And in that, the energy really needs to go to originate, discuss ideas, pick the best investing. If you need to worry about Politics, how you need to behave or not challenge or challenge. There’s so much energy leakage out of a team or an organization. So that frustrated me and triggered to think, well, if I start from scratch and I can set the culture, I can handpick a team. I can obviously ensure that we have none of that, that we can be a group of individuals with different backgrounds that burn from the same purpose in delivering those returns very often for pensioners, but in a way that then avoid negative aspects such as Politcs.

Ross Butler (05:29):

And so you’re only what three years in that state. I mean, how’s it going from a cultural perspective? Have you been able to, introduce that kind of different culture?

Mirja Lehmer-Brown (05:39):

Yes. It’s, it’s um, it’s going really, really well. I mean, you know, back into the entrepreneurial aspect, it can be scary too, when you haven’t done that before. And you can question yourself whether you’re able to, I mean, from sheer experience, point of view, you build so many networks, you build so much pattern recognition that, that clearly you can take with you, but, but you know, where people come and join you as an individual, is scary. But I think the fact that we talk with so passionately about the fact that it’s team-based and that everybody is equal if you will. And we start, we start with the junior people, sharing their ideas fast up into the senior, and there’s lots of frustration. Now, the private equity industry has grown up and many of these organizations have been quite large.

Mirja Lehmer-Brown (06:33):

That means lots of mid-level and junior, uh, uh, staff. If you’d be, look, people are frustrated with the same thing I was frustrated with. And if you see the people we were looking for, work Lilly, high-ability ambitious people, but then driven by the same values and principles of team, of responsibility of doing the right thing, are working hard clearly, but fact-based. And then also this continuous improvement mindset were also the senior people want to invest in the junior, learning by doing the type of job. You don’t read some books or become a good investor, but genuinely if you have as a mid-level and junior in a person genuinely feel that the senior person sit there for you, side-by-side they roll their sleeves up and want to transfer that knowledge to you. It’s a wonderful proposition. And hence it took a little while because it was not noon, you know, from a brand perspective on the equity side, but windows discussions, clearly lots of people that didn’t fit in.

Mirja Lehmer-Brown (07:42):

But there were a lot of people that were intrigued and were really looking for the same things. So now we’re a team of eight people and again, operating very much under those types of ideas and principles, you know, living, breathing that culture. And hence, that’s the most satisfying we are, did the strategies working and the performance coming through strongly now after three years, which again is interlinked. It helps the culture help the feeling of wanting to come to work. You know, the belonging of being there when it all works. But I think it’s driven very much by the cultural elements of it.

Ross Butler (08:23):

Yeah. Success definitely helps. Did I hear you say tha, junior people speak first?

Mirja Lehmer-Brown (08:29):

Yes. Around our, so our investment processes such, institutional three steps, that’s no different, but when we, um, you know, start in the team, so the first lab level, the one-pager, everybody is expected to readapt to a certain degree and we start with the most junior person. They need to share their views fast. And, everyone comes in many have banking background when they come in more of the mid-level, people when they joined, came from private equity, but none had really had that experience before. So when they joined the team meeting and were discussing ideas, they were not prepared. She was say, first time around the fact that they needed to express their views. First, second time around, they were very prepared. And why we’re doing this is it’s the same thing. As many things you can’t tell to children to avoid mistakes, they need to do it themselves in order to properly learn and invest in.

Mirja Lehmer-Brown (09:32):

There are so many different aspects in the pattern recognition. You know what you need to think about. And we obviously have strong protocols and processes to help along the way, but it’s really your judgment. Your thinking. If you listen to other people, you don’t really learn what is important. If you need to read about the company in a situation and you come up with your views, a unit of thought it through it’s your views. Um, and very often initially they are not filtered or the weightings are not, you know, where it should be, but it doesn’t matter because, for us, it doesn’t matter. It’s the only way to learn. So we look at a lot of things. We originate a lot of things. It’s part of our model, but we do be very, very disciplined. So we do very little, but the more we look at, the more we discuss, the more we learn and the more they learn in, changing, adjusting the way your thinking to become more balanced in their view and also go away from, is this used to good company and just come to a good company. It doesn’t necessarily become a good investment if you pay too much. So it’s just learning around companies is certainly important management teams and pricing and structure and part of value creation. And, and with that, quite quickly you can see the evolution in their thinking, their alignment with the filter, and how we assess where their, a situation is a good investment or not. And that’s also great to see

Ross Butler (11:03):

Tim said to me about, diversity, but from a very broad perspective, um, which is making sure that you’re not hiring in your own mold and making sure that, everyone, not just from the gender or racial perspective, but also in terms of, uh, the way people think and their economic backgrounds and all of that. But it can be in practical terms, it can just be very easy to, to, to instruct a recruitment agency to say, we want people from Harvard and Oxford and, you know, and suddenly you’re already going down that route. To what degree do you feel you’ve achieved some level of let’s call it intellectual diversity around the table so far.

Mirja Lehmer-Brown (11:37):

Yeah. And there are so many layers to it and we are eight people, but we are all different nationalities. And many of us have, not even two, I’m half Swedish, half German, and that’s only part, but, you know, it’s the language, it’s also the culture, the way you have been brought up, which then, the principles and values, because while do want, diversity in thinking for sure, diversity in pattern, you want a different type of pattern that recognition, but you still want the same values. You need to find a group, that, that those principals on why we are here needed to be the same, even if we are value-add from the pattern recognition in analyzing deals

Ross Butler (12:21):

Now in terms of your actual business, maybe could you set up for us, you know, your mandates, what, what you are investing in and where are your sources of funds?

Mirja Lehmer-Brown (12:30):

Yes. So we are, continue we’re backed by our Canadian as a British Columbia investment management corporation. And the strategy is the European mid-market. One of the things when I analyzed, uh, you know, setting up in 2018, because it was different when Haven was founded, they were very early into a new growing market that, the market of direct lending, private equities, quite mature. So one of the things that we did, I feel that the, in my view, the private equity industry has created silos very often. There’s a separate, product for primary funds or a second, separate silo bucket for co-investment or a sec, you know, secondaries have a different bucket. And I felt that for us doing mid-market, we don’t want any restraints. We want to be able to originate across the board and just focus on picking the right that the best opportunity is flexible across your mid-market.

Mirja Lehmer-Brown (13:30):

The larger funds, larger companies to a degree, you can say, I guess it’s less risk. So it’s a different style of investing and different returns, mid-market, or to generate, a premium return in comparison to the larger market. But if you look in the dig into the track record, people have all failed in doing that. And it’s been too much volatility. So when we set up, but we want to do, if we have one bucket allows us to, one year, maybe they’ll be more opportunities in, in co-investor as of late, this GP led, uh, secondary, a single secondary, which we do in Medan, several of them, but it’ll go, you know, one year or another year, it’s slightly different. If you only could do one type of investing, it’s very hard. And also very often the solutions we do, the fact that the same team can do a combination of investing that otherwise might fall in between the buckets is very powerful.

Ross Butler (14:31):

So in larger competitors, would there be a separate team for co-investment, or all your guys, do everything?

Mirja Lehmer-Brown (14:38):

All the guys, do everything to avoid things, falling off the cracks and allow for, for more opportunities and more discipline in what we do. And that’s been really helpful. And it’s already evolving, we’re now on our second program, and it’s gone from slightly more funds than you start out, also generate some of the co-invest opportunities to now coming out of the COVID where, this GP led market on the concentrated end, which has been around for a long time, but it’s really exploding. And that suits our skillset because we have built a team of stock pickers, very well. And we don’t, again, because we haven’t got a bucket. We don’t mind, it’s an asset opportunity. We don’t mind if you call it a secondary or a co-invest in what we do. And, also we find that the relationship, uh, from the primary side because the core thing with the GP led is also understanding why, why do they want to do this? And it’s the right thing for them and the acid, which if you have followed funds for 10 plus years, and they know the individuals in these funds, you will have a much stronger view on whether it’s the right thing to do. Not just numerically, but because we focus on both. So you gain that experience from primary funds investing is very helpful across the board. But particularly I would have said in the GPLS single secondary situation

Ross Butler (16:13):

When you’re setting up a new business like this, I guess the challenge is that you don’t have any existing relationships because the best managers will have long-standing relationships, although you were in the market yourself before.

Mirja lehmer-Brown (16:29):

Same thing, the principle of Hayfin, working with very experienced people. So, we hired Gonsalo Aras who co-led this, the private equity solutions team with me are very experienced from different some overlapping, but predominantly, uh, different parts of Europe and different types of relationships. So we bring that eminent relationship that you have as an individual is personal, it’s partially linked to the brand. It’s got its widows where you stand for, but moreover, when you’ve gone for, for, you know, over 10 years and, and quarterly knocked on the door on people to have a coffee, the Swedish way to have a coffee, that’s how you build trust that you take with you, because in the end now, in particular, there is so much capital the capital in it says, doesn’t matter. People want to choose an individual relationship that they feel they can work well.

Mirja lehmer-Brown (17:32):

It needs to be a high-quality type of capital, the quality of capital matters, but its excess. And then you go down to a more personal element. Is this an individual? I feel I can trust, is this, we can have a dialogue with somebody that is constructive and helpful to us. And that’s in the end to me why people choose, to work with somebody in a fundraise or in a co-investor opportunity or in this teepee lads, they’re really attractive opportunities. GPs have a choice. And the choice very often in who they select is just part capital and a lot about who you are and what you stand for and what type of relationship that you built.

Ross Butler (18:18):

Yeah, it’s a people business because you’re committing, you’re not just investing.

Mirja lehmer-Brown (18:24):

And I do think the nice thing, the additional benefit from setting up the entrepreneurial side, which originally I didn’t think of. So originally we’re more of the strategy being differentiated, the culture, being different shaded, and also the discipline. And I guess the credit focus from Hayfin to avoid the volatility in the mid-market. But the additional benefit is we are not entrepreneurs. The whole team, we call, is the founder team, every single one of my team, we are together. We are, the founders are our track record together. And we built this from scratch that also when we sit down very often, the mid-market, they’re also founders of their funds. So we can discuss the challenges of hiring people, motivating people, motivating the younger generation with certainly different to kind of the older generation systems, how that work or I see, but it becomes a different type it’s equal partner to partner. And we’ve gone through the trenches in a similar way, which also add to that, you know, the strength of that relationship.

Ross Butler (19:35):

Can I ask, what proportion are you roughly, in terms of, direct fund payments versus the more tactical approaches, co-investment and secondary and so on, and where, where would you like to be?

Mirja Lehmer-Brown (19:48):

You know, the core initially is the flexibility and the first program. So the first investment program was more than 55% funds and, you know, 45% asset opportunity because we don’t really split whether it’s co-invest or a GP-led opportunity. Out of COVID came an additional need for asset capital. It was too much, co-invest capital, but not always co-invest capital in the professional form. And, you know, out of it came, people want to work with a professional partner, a partner from the co-invest, not just in this indication, a partner that can be fast and have their own view, their own view of the asset that underwrite the asset themselves. They, you know, through COVID there were issues in co-invest and some, LP co-investors were worried about the performance and that created some friction in the relationship, the GP and LP so that, you know, the evolution of that was that the GP was happy or to work with somebody who did their own work.

Mirja lehmer-Brown (21:05):

So, you know, if we pick wrong, it’s not the GP’s fault, it’s our team’s fault that this, we would never blame a GP for offering us an opportunity. It’s our own process. And we would, you know, I don’t like blaming, but we will make mistakes, but we will be in ourselves. So that I think has been very, positive. So we’ve actually seen way more co-invest opportunities than I thought beyond the fund investments that we do. And then as I indicated, this deeply led market, this is full exploding. So the new program that we’ve started, or the second program we start,

Ross Butler (21:40):

Can I just ask you a question about, co-invest first, and then you can tell me about GP.

Mirja Lehmer-Brown (21:46):

I’m just going to say, so the proportion is 70%. So now 70% asset opportunities and 30% funds

Ross Butler (21:51):

I’m sorry, you still answering my question. 

Mirja Lehmer-Brown (21:54):

I was trying to 

Ross Butler (21:57):

It’s a different skill set, isn’t it? Assessing single asset opportunity versus, and so you’ve got a team of eight and they’re already looking at fund investment co-investments and these tactics, and, but they’re also looking at, company’s specific opportunities.

Mirja Lehmer-Brown (22:12):

So the co-invest, that’s why in the secondary market, it’s been a lot of this LP stake. So when an LP center sells to another LP, we don’t focus on that. That’s very different. It’s broad, diversified portfolios, it’s more cashflow pricing. So that’s not, it’s a very good market to be, but it’s not what we do, but where we have married every single one that we have hired, our focus on developing skills, in picking an asset, which is also aligned with, HayFinn is just from a credit perspective versus the equity perspective. In addition, my view has always been that if you are a good fund investor, that will help you as well to understand because when we select an asset, it’s not used to kind of do the numbers on whether that is a good investment. We very often need to understand why is that GP the best owner of that assets?

Mirja Lehmer-Brown (23:11):

Why would they be the good part of helping the value creation in that business? And that are more aspects that you focus on from a fund investment perspective. So certainly, you know, it’s certainly super value add even if the core skill to a degree is the fact that peeling the onion on the investment on an asset investment opportunity. That’s why, if you now go and look at very often the large secondary funds, they have predominantly priced cashflows because the market on the LP stakes side was so much bigger. They need to carefully think if they now, recycle their individuals to look at this more focused opportunities on the secondary side. One very often risk-return spectrum, very different from this portfolio, diversified cash flows. And as you rightly said, the skill set needed to do that is also very different.

Ross Butler (24:16):

So kind of from a philosophical perspective, your team feels almost more aligned with the GP mentality than perhaps the traditional institutional LP mentality. Would that be fair?

Mirja lehmer-Brown (24:28):

I think that’s a very good observation because we work very much like a GP. We source a lot of situations and we are very disciplined around the picking, and think much more like an act in that sense, much more like a GP.

Ross Butler (24:48):

What is it that attracts you? What would you look out for?

Mirja Lehmer-Brown (24:51):

That’s a very interesting question and actually linked, uh, the mid-market and pitfalls of the mid-market. Because if you look at the larger funds, CVC, or admin, it doesn’t tend to be people-dominated anymore. They have very strong processes. They have sector teams, they’ve got lots of operators around, they still need to be mindful about culture and how they drive organizations, but it’s a different type of diligence. In the mid-market, it’s much more, person and culture-dependent. When I started in 2006, the, um, the way people did fund investing back, that was much more numerical. You went through a track record and then, you know, from that track record, you looked at the processes and the track record. And I thought, oh, this must be good people in the future as well. And then I said, but how can that be?

Mirja Lehmer-Brown (25:47):

Because that investment will never come back. So the motivation of, and the process of choosing it and the skill set in the people align, those are the more important elements to review in order to access future performance. So in my own learning, coming from the sell side, it took some work, but I really felt that that lots of people went about it the wrong way, just focusing on numbers. So from that came a completely different type of filter, a hundred-point scoring system that, in addition to strategy and, processes and track record very much focused on the culture. Leadership, what are the motivators? Why are these people doing this. Organization? And the room in the ration linked to organization. Decision-making, functional team, dysfunctional, and those elements are much harder to assess, and to figure out, you need to look for them and you need to build that pattern recognition to see what works, what doesn’t work.

Mirja Lehmer-Brown (27:08):

We are very focused on team-based. Very team-oriented, team-based decision-making teams, where also remuneration tends to be diversified if you will, rather than very strong founder-led businesses, because we think it is, reducing risk as one element. And the fact that back to what we said, that you haven’t got the dominating individual that shut challenge out, it could temporarily look good, but again, that’s a risk from our point of view. And very often when we go in meetings, the questioning is very much. So why are you here? What motivates you over and over again, with every person in the team to get the sense for what they’re saying, what they’re not saying, and, the general, yeah. To try to assess that culture again, because that we have found is a core KPI in assessing future performance.

Mirja lehmer-Brown (28:15):

You need to have local reference points, not their reference points. Very often, I say, that’s why it’s so fundamental to us to be local. Well, I’ll figure out I’ve gone to school with you. Uh, you know, in that referencing is there is a joined connection. We’ll have worked together. We will have gone to the same school, I’ll know someone that knows someone that will know your neighbor in order to that picture, that you tend to portray of you and your team, whether we feel that that’s transparent and true. So we do that first-time funds, which we do. We tend to do 50 reference calls, most of them off a list, and that you can only do if you have long-standing relationships on the ground that trust. And we’ll tell you because they know that your integrity is integral to who you are.

Mirja lehmer-Brown (29:11):

They will tell you how it is, and that is impossible to recreate if you’re far away and impossible to recreate in the mid-market because the regions are so different. Yes. So the portfolio is doing, doing well. Is it really well? Yes. And I think the third thing with this and discuss starting in 2018, setting it up, I thought we would have had a recession since 2016. So I was a bit afraid of 2018 as a starting point in setting up a new program. And so the third part of how we were doing it was to focus on a really resilient, resilient sector and resilient business model. And that was predominantly the timing, the 2018, and that belief in, within the investment period, there will be a correction. And from that, and LinkedIn to in Europe, you haven’t got as many sector funds as in comparison to the US but we believe in sector funds in that, again, it’s the pattern recognition.

Mirja Lehmer-Brown (30:15):

If you spend way more time in one sector, you can reuse your learnings much faster. And with that, the portfolio with them put into the ground in the first program is 70% healthcare and technology combined. And the rest is resilient service model. So clearly we had no idea about the health crisis, but we’re preparing for a correction. So with that sector waiting not only is our performance, the operational performance of the businesses doing exceptionally well, however, from being a high priced environment, the investment that we’ve done has rerated because now everybody wants to do healthcare and technology and resilient sustainable business model. So we have been fortunate not only to have an operationally well-performing portfolio but something that is also been rerated from a relations perspective.

Ross Butler (31:20):

Fantastic.

Mirja Lehmer-Brown (31:21):

And a bit of luck is not bad.

Ross Butler (31:24):

What are the circumstances that you think are legitimate and would attract you to a GP led and what would turn you off?

Mirja Lehmer-Brown (31:32):

It’s evolved initially the, GP leads were for assets. Maybe they hadn’t gone that well and maybe needed a little bit. They still, so the GP believed in that asset, in the value creation of it, but it had taken longer. So that was a position, I mean, necessarily not a weakness, but it wasn’t a strength. And that has evolved what people now are focusing are really trophy assets, assets that are significant winners and with the pricing environment and additional competition, that are now out there, it’s really hard to find really good businesses. So if you have built a great relationship or maybe even changed and put them place a phenomenal management team in a very resilient business, but the underlying structure of a private equity fund is such that after a period of time, you need to liquidate it, you can argue. So why would I sell this to a larger fund for them to create more value?

Mirja Lehmer-Brown (32:41):

When I got hold of this company helped build this to better business, and my LPs can continue to be the beneficiaries of this good returned. So we think creativity is positive. It’s giving GPs more optionality in a market where it’s hard to find those assets. It’s not like every asset in a fund is of that exceptional quality that we are looking for, so that you de-risk it, from buying him to the next three to five years, you know, making a new plan and, and a feeling that this is a good thing to keep that business. I guess it’s linked to, if you look at the public markets, I don’t know the exact statistics, but a significant percentage of the increased market value or the value creation is actually linked to a very small group of companies. So again, the significant winners tend to be the one that continues to drive premium value creation. And those are the ones people tend to want to want to get hold on to. And with that, it needs to be high-quality process clearly, cause there can be conflict in that decision, but it also needs to be alignment. So you can’t just do it because you want to increase a UM you need to also align yourself also with your own, the GP capital, and behave as a buyer and a seller in that situation.

Ross Butler (34:21):

And do you normally, have to partner with other providers, or do you do the GP secondary on a solitary basis?

Mirja lehmer-Brown (34:28):

So depending on size, we tend to invest 20 to 15 million in an investment, either be the fund or a situation. So we have had a number of situations from these discussions going out, speaking to the GP community where we have been in a bilateral discussion to two LPs, if you will, into a situation. Cause we don’t want to be midority. We are minority investors if you will. An LP minority investors to then the largest situations where it’s more a larger group, you know, from five to 10 different investors into that asset.

Ross Butler (35:13):

And you said you’re seeing quite a few of these opportunities out there probably because things are becoming so polarized.

Mirja Lehmer-Brown (35:20):

Yes, it continued to go, we say, you know, let’s see right now it’s math, it’s the fastest-growing part of the second dairy market. No question. And there are a number of opportunities. So I think this will go on certainly for the next two to three years, but there’s always something else that happened. It could be one or two of them that maybe don’t perform that well, but you can also see a lot of people are hiring. A lot of different companies are hiring to address the growth in this market. So whilst it’s certainly going to grow for the next few years, I do believe some people are certainly banking on it growing for a long period of time ahead, but we don’t need it because we have other opportunities to, to invest in as far.

Ross Butler  (36:13):

In terms of how your team, your business, as it was sits within Hayfin, sits within the culture, but also the strategy and any kind of cross-fertilization of ideas and opportunities. How does that work?

Mirja lehmer-Brown  (36:29):

You know, initially again, more experienced people, more pattern recognition, and in different fields, that can be a value add. So just the fact that we know, GPs, where also from the credit side, they might lend into businesses is intelligence people, intelligence networks are always helpful, different angles based on different experiences. And that’s been very easy. It’s very easy because it’s easy to, to me, you need to be careful about some of the walls. So it’s, you don’t share detailed information, but quality of people or whether they got experienced or not in that type of field is something from the PE side that can be helpful. We came with much more of ESG processes because it started earlier on the equity side in Europe than on the credit side. So we work very closely together. You know, the PE team has been able to do ESG profiles of when the credit side work with P houses, we are involved from an ESG perspective from a profiling point of view, rather than they do the deal clearly kind of ESD analysis themselves.

Mirja lehmer-Brown (37:49):

So it’s very beneficial what we’ve now started to do. And that’s even more exciting, is we can make investments together back into what we’ve said instead of staying in silos. We have now two recent deals where we work together with the special opportunities side in creating a capital solutions for AGP into an investment where there’s a peak element and an equity element. And they are not that many of our competitors that actually can stitch together tailored solutions across credit and equity for a situation which, we are about to do our second now and I just expect that to continue. So that then start to, you know, even deeper working together across the teams and then the practice based on this team-based, culture in that, we are, we are super happy if we can work together and create solutions.

Ross Butler  (38:53):

So it’s an equity co-invest with a credit element attached to it, all from the same provider. And how does your decision-making process in terms of governance work and how does it align with the rest of Hayfin?

Mirja Lehmer-Brown (39:08):

So we have our own investment committee. So, you know, the private equity investment committee contains about the senior members of our team and senior members of Hayfin and the special opportunities have a different investment committee clearly. There are some joint members and the learnings from one will apply to the other, but it’s also the focus. Again, the credit focus is different. The type of analysis is somewhat different, different from depending on what angle you come from. Yeah. And, something that was super beneficial was coming into this, COVID, working together was actually, we have a tremendous high yield and syndicated loans team, which are operating in the liquid markets. And with that, a higher degree of macro focus, that goes into their analysis. So coming into COVID, nobody, we’ve experienced the financial crisis, but not this a health crisis members, senior members from the whole firm working together, trying to figure out what is this, is it temporarily or is it something that we’re going to go into. A lot of people are going to die for a long time and it’s going to be a very different type of situation. So Gina Germano and her team had lots of phenomenon analysis that was very helpful in creating scenarios, right?

Mirja lehmer-Brown (40:44):

Where do we think we’re going scenario setting that was helpful for all of us. And as a group, as a house, we then come up with a scenario that we used as a base case and, every week or so we were assessing, is these the data points that are coming? Is this a valid scenario? And I think that allowed us also in 2020, where a lot of people, at least up until after the summer did not deploy that much. We were able guided by facts and scenarios and analysis working together. Our conclusion was that we can deploy. And we had a record year in 2020, across the board deploying in our different, product areas based on his intelligence and views of working together.

Ross Butler (41:36):

Did the private equity industry is a little bit slow at deploying during, during 2020, but, I mean, it’s a very difficult time because the economic situation has never looked more uncertain. I personally, I think, it still looks incredibly uncertain, and most private equity firms don’t have a chief economist. They don’t tend to even worry about the macro view in my experience so much, they take a view on people, but in a situation of radical uncertainty, perhaps they might need to take more of a view. I mean, I’d be, I’m sure it’s all trade secrets, but I’d be fascinated to know in general terms, what your outlook is with regards to the economic prospects of Europe.

Mirja Lehmer-Brown (42:18):

And I think you’re absolutely right. I think there are all sorts of elements that go into kind of the analysis of what you do. And I do think some of the larger houses definitely apply and have asset allocators based on more the macro, the research macro judgment helping in selecting the underlying businesses. And, you know, we are with that, you know, low growth, uh, for sure in general is something that we think will be here. We had the health crisis currently the aftermath of that is energy issues, supply chain issues, and still too much liquidity into the system. So whilst, you know, over the next little while is, seems like it’s still catch-up effects in a positive sense that are trending. There are certainly clouds out there that could lead them to volatility.

Mirja Lehmer-Brown (43:18):

So I think volatility, in general, is here to say, that’s why with the math typically trying to focus on thematic sectors, which have then growth. So megatrends that, that provide tailwinds. And that’s also LinkedIn. So initially when we said we’re focusing on healthcare and technology, it was more around the fact that we liked that pattern recognition. We liked the defensibility of it in preparation for a correction, but as we evolve and the content constantly need to reassess what we do, we’ve come to think because of the volatility and because in general, lower growth in Europe, if we focus on an aging population, if we focus on digitalization, those are longer-lasting trends that are structural, and we’ll continue to see growth, even if lot of other areas will temporarily go down in a volatility in order downwards adjusted scenario.

Ross Butler (44:24):

In terms of your, your own, section within Hayfin, what does the future hold in terms of growth? And do you have a growth strategy? Is it to just gradually increase your number of relationships or would you consider introducing, I’m not sure of the exact term for it, but the new sources of funds or even grow by acquisition of competitors.

Mirja Lehmer-Brown (44:47):

So, I think we were all growth-minded. So in order to continue to evolve, there needs to be some growth. And with that, we’re having a number of conversations with other similar parties, similar to BCI. So we will grow somewhat by adding, a more diversified investor base, but still though, and that’s very similar, across, Hayfin we do believe in being disciplined, you need to grow. That’s a positive for any organization also for the younger generation coming through. You need to show growth, but not for the sake of it. So disciplined growth. We still believe in ensuring that the right balance in how much you wanted the blot and that’s what’s leading us to the amount of capital we’ll take on. The strategy it’s scalable, particularly on a GP led or some of the co-invest we could have, instead of doing the 20 to 50 million, we could easily have invested a hundred million in several of those situations and the same goal with the fund, but not necessarily 500 million. So ask the market evolves, we will evolve with it, but we will stay on the discipline side because the discipline is also the guiding light that will allow us to act before.

Ross Butler (46:25):

Great. Well, the very best of luck with it, Mirja, it’s been really nice hearing about your startup story, I guess.

Mirja Lehmer-Brown (46:32):

Thank you very much for having me, my pleasure.

Ross Butler (46:36):

You’ve been listening to the Fund Shack podcast, make sure you subscribe and visit our website at fund-shack.com for many more video interviews. It’s the private capital channel for alternative investment professionals. Thanks for listening.

#29 Luke Johnson, entrepreneur, investor, philanthropist

Fund Shack
Fund Shack
#29 Luke Johnson, entrepreneur, investor, philanthropist







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In his 20s, Luke Johnson led the acquisition of Pizza Express and as chairman, helped it become the UK’s leading pizza brand. He has since established and helped develop household names, Strada, Giraffe, the Ivy, Zoggs and Integrated Dental Holdings, as part of his family office vehicle, Risk Capital Partners.

He is a successful newspaper columnist, author, former chairman of the Royal Society of Arts, and current Chairman of The Institute of Cancer Research.

In our exclusive podcast, Luke provides a critique of private equity, a critique of public markets, a critique of lockdowns and some of the most sensible advice we’ve heard yet about how businesses should be run in this brave new world.

Uncorrected transcript\some inaudible parts

Ross Butler:

You’re listening to a Fund Shack, private chat number 29. Welcome to Fund Shack. I’m Ross Butler, and today I’m here with Luke Johnson, a well known entrepreneur, businessman, philanthropist, and private investor, Luke. Welcome. And I have to say thanks so much for coming to meet us physically, because this is the first time we’ve been back in the studio 18 months and personally I think it makes a real difference. Nice to see. I was looking over your bio in preparation for this. And I had to say, and I don’t say this just a flatter you, but I was amazed at the breadth of your undertakings and your achievements. So you’ve got obviously a varied portfolio. And within that I recognized about three quarters of the businesses. Now you do consumers, so maybe that’s not so surprising, but that leap out of me, then you’ve been a successful newspaper columnist over years, if not decades. And I know that that’s not easy to sustain and you’ve been very active on the philanthropic side. You’ve publish books. This is quite a productive repertoire. Now you only get one life, so it obviously doesn’t seem strange to you, but why do you think it is that you’ve managed to be so productive across so many relatively varied domains?

Luke Johnson:

Well, I think I’ve always liked to be busy and I have a father who has had an extremely long career and although he stuck to the one career of being a writer, a journalist and a historian, he, he was incredibly productive and wrote many, many millions of words and published 40 books and so forth. So I think he gave me a good example to follow as a role model. And you know, to a degree, I think life is what you make of it. And if you have the energy, there are always opportunities. I think given that most of us perhaps we’ll live to, you know, be in our eighties. That means we might well have a 50 year working career. And it seems to me, therefore that we should all plan to have at least two different careers and possibly more I’ve always been interested in people who’ve done a variety of things rather than just one profession and stuck to that their whole working life and then retired. None of that interests me in the slightest.

Ross Butler:

It rather goes against the grain these days, cause everyone wants to specialize to such a great degree. And if you’re seen to be your specialist in more than one area you’re seen as an amateur in at least one of those,

Luke Johnson:

Well, there may be some truth in there. And I think I could be accused of being a [INAUDIBLE] at some things in life. And you know, I don’t deny that if you diversify, then you may have less depth and you know, there are advantages to focus and specialization, particularly in the modern complicated world. However, the point you made at the beginning is we only have one life. It’s important to keep interested and lively. I think for example, take philanthropy. I’ve served on the boards of a number of different charities and nonprofits over the last few decades. And one of the great advantages of that is I think it teaches you things and you meet people that if you are only doing business, you wouldn’t. So I would actually encourage all successful people in sectors like private equity or venture capital to seriously consider whatever age, but say in their forties, the idea of becoming a trustee of a school or hospital or some other nonprofit, because I think it broadens your horizons. And that should be partly what life’s about. I think there is a risk if you only do one thing, you get dull and you repeat yourself and the needs to be more to it than that. I think.

Ross Butler:

Yeah. investing itself is very nature. Kind of it’s, you’ve gotta have a broad outlook on life because you know, you’re looking at different sectors. You are not the specialist, you’re not the, in most cases, the executive, the doer, you’ve gotta stand above that. So that will kind of make that, that probably adds to your ability to be a successful investor.

Luke Johnson:

Maybe I think one of the challenges for private equity is that although they pretend to themselves, they aren’t the specialist in terms of how to run a business or a particular industry. I’ve sat on boards with private executives who are there telling the managers how to run the business and making decisions that I think should be delegated to the executives who are full-time in that business. And the arrogance sometimes are private equity executives in thinking they know best let’s them down. I think there are some areas where private very good, you know, buying and selling for example, raising finance, they’re pretty good at that. Some of them are pretty good at picking talent but above and beyond that, you know, knowing markets, knowing competitors, you know, understanding the intricacies of the technologies that they’re working with, really being able to spot the best executives at the operational level to work with. Mm not so sure

Ross Butler:

I’m sure you’re right. And I actually, I think I do agree with you, but to play devil’s advocate slightly, if it didn’t work, would they, would they do it? It’s certainly the trend is for greater activism and certainly the institutional investment community buys the idea of interventionists private equity firms. So presumably they look at the data and think, well, those that are a bit more muscular in their approach with executives do better. There must be some cause in effect,

Luke Johnson:

There probably is if they’re the right private equity firm and as you well know, you know, it depends which quartile of a PE house you are talking about. I think we’re all humans and I think private equity investors have as much ego as anyone. And, you know, according to Maslow’s hierarchy of human needs, once they’ve developed a certain quantity of wealth what’s next, and obviously what’s next is some degree of status. And that would mean them adding value and making a difference and being important in the ownership so that the value accretion is partly thanks to them. Now, I would normally accept that the financial engineering aspects of deals are probably down to the PE house. I have they bought it on a low, multiple, can they sell it on a high, multiple, have they added the right amount of lever to goose the returns?

Luke Johnson:

Have they made a clever bet in the first place? All those things of course are down to them, but, above and beyond that, you know, quite often I think, you know, it’s debatable whether they really make a difference. Now, I think there are some very good private equity investors. And I, I would say on average, you know, successful private equity investors are clever people. And, you know, obviously if they succeed and they, you know, get backing from limited partners and, and show good returns, then they can’t be that thick. However, it’s amazing what lever in a rising market can do.

Luke Johnson:

And, you know, generally speaking over the last two decades, certainly, you know, it’s been a pretty good game to play. I would say private equity in terms of accumulating returns for investors and indeed enriching private equity investors. I think, and I’m not talking about myself so much, cause I’m not really an institutional private equity investor or executive, but I think it’s as good a career as one could pursue, if, you know, you want to get rich in a pretty safe way because you are playing with other people’s money to a very large degree and you know, you can write very big checks. And so if you get your bets right, then you do extremely well. And to a large degree you know heads say wind tails, other people lose. So, you know, private equity as a career has proved a pretty good bet. And I suspect it will continue some time because you know, there are a lot of organizations raising big funds and there’s a lot of parcelling which to a degree, you know, is self-fulfilling

Ross Butler:

So, you’ve packaged yourself up to some degree as one of those people, because yes, you are not an institutional, but you’ve got risk capital partners. You could have just been Luke Johnson, the big wealthy investor, but for some reason you see it as useful to be seen as part of that community.

Luke Johnson:

Well, I think probably a lot of people prefer to deal with a brand, an organization rather than an individual. I think an individual is more egotistical inevitably. I think when we set up risk capital partners over 20 years ago the sort of private office was much less common, I guess, if one were doing it now, you know, that’s what I would do. Also. I have more money now than I had 20 years ago. In the meantime, we also did raise a fund with limited partners. And you know, it’s say for one, an investment is now spent and we’re returning funds and it will show a good return to our LPs. And I think it’s been a success, but I didn’t wanna do another one. The point about a fund of course, is it’s a very, very long term commitment.

Luke Johnson:

It’s really a 10 year commitment from all the partners. And indeed obviously the limited partners. So it’s a very unusual structure in terms of most jobs, if you like. And, and it, it really is a partnership arrangement rather than employment arrangement and all the longevity and loyalty required that, that displays. And indeed, I think if you look at the history of most PE houses that have fallen apart more often than not, I would say it’s cause the partners fell out, you know, and that may have been because they made some bad investments, but quite often it’s literally personality clashes leading to the, you know, founding partners of the organization, not getting on etc. And that’s what leads the LPs to then dessert them. But I’m not in denial about the fact it’s a lucrative and on some levels successful structuring of buying assets, because I think there will always be the advantage they have over say, public companies in private equity are virtually, always willing to buy and sell.

Luke Johnson:

Every asset is for sale. And they are always willing to buy a new asset. Public companies are slaves to the cycles of the stock market. And very often in my experience, public companies are forced to sell at the bottom and buy at the top. And it astounds me how often I come across situations where there’s a public company in a particular sector that will know that industry very well and have huge synergistic advantages of making a strategic acquisition, but for a variety of reasons, they’re too slow or it’s at the bottom of the market or whatever. They can’t make the acquisition private equity, which doesn’t know the industry as well. And doesn’t have any synergistic benefits makes the acquisition and then flips it to the industrial buyer a few years later at a huge profit. And, you know, you wonder why does the public market always end up paying more? And I guess it’s because private equity are ultimately really M [INAUDIBLE] specialists, all they do is buy and sell in a sense. And that’s what they focus on. They’re small and flexible and they have this great timing advantage, which really plays to their strength.

Ross Butler:

I agree with you. I think it’s it’s one of those things and there isn’t a problem with it. As long as the, those rewards are accessible to as many people as possible. One of the problems is that anyone can invest in the public markets, but it’s, it’s increasingly easy to invest in private equity vehicles, but it’s still pretty difficult for your average job.

Luke Johnson:

Yeah. And of course, as we know, private equity still only represents a tiny proportion of the overall savings and pensions money out there. And as a proportion of overall institutional individual portfolios, it is growing, but it’s still, I would imagine worldwide, you know, under 10% across most diversified forms of savings. And it, it is gonna grow structurally more allocation is gonna be devoted towards private investments once or another, be it VC or PE. That’s probably a good thing. I’m not surprised even though, you know, two and 20 relative to public market management fees is I, the level of attention required investing in private companies is a great deal, more intense. So, you know, I would argue it’s, it’s justified to an extent and the returns are there. And another area where I think private markets have an advantage is they are more willing to put higher levels of debt into investments. Generally, my experience public company fund managers, don’t generally like to invest in companies that have 3, 4, 5 turns of [INAUDIBLE], senior debt. Whereas many PE houses are perfectly comfortable with that. Indeed. They would consider that a standard lever of leverage for a normal buyout. So, you know, that financial engineering in rising markets and growing businesses, compounds returns. Yeah. And  it’s an another advantage that PE has over public markets. So

Ross Butler:

Just at this point, can we step back to some of our international listeners might be wondering where have you come from, if you are not a mainstream private equity guy, could you give us a quick potted history, maybe looking, starting with, well, wherever you like, but particularly like Peter express as a signature deal.

Luke Johnson:

Sure. Okay. So in my late twenties I, and a, a group of partners took control of a private business called pizza express. We merged it with a a group of franchise restaurants, pizza expresses, arguably the leading pizza chain in the UK. It’s been going since 1965. We took control of that in 62, 63. We took it public.

Ross Butler:

Wasn’t it ’82?

Luke Johnson:

No, ’92, ‘93.

Ross Butler:

Sorry. Okay. Sorry,

Luke Johnson:

Go. I’d only just graduated from university in ‘82.

Ross Butler:

You said ‘62, so yeah, you’re Right.

Luke Johnson:

Yeah. ’65. It was founded. ’92, ’93 we took control of it. We took it public, and it was very successful. And I was chairman of that during the nineties and, the chairs rose from 40p to eight pounds more. And, off the back of that, I then started doing more deals. It initially mainly public company deals. And then through the later nineties and into the two thousands, many more private companies, and, you know, over the decades, I’ve probably invested as principle in 50 or more businesses with a strong bias, as you said, towards consumer and in particular areas like, hospitality and leisure, mainly UK. And you know, at the smaller end, I, I would characterize the classic investment I do as development capital. That’s my preference.

Luke Johnson:

So frequently backing a founder not always taking a majority stake, quite often, a minority stake. Yes, we do buyouts, but quite often, not and pretty flexible in terms of the types of deals we do in the structures. And I think that’s because to a fair degree, most of the time we’ve been using our own money, my money. And so we can do bigger and smaller deals. We can do longer deals. And clearly we don’t have to do any deals at all. I think one of the reasons I chose not to raise a fund when our last one was exhausted was, as I say, it’s a 10 year commitment. I’m 60 next year. And I didn’t wanna be marching into my sixties with a sort of, you know, seven, eight year commitment still to go of making, you know, a minimum number of investments and a minimum amount of capital deployed every year.

Luke Johnson:

And it’s been very interesting to me over the last 18 month, with the pandemic, a lot of private equity houses, particularly in 2020 sat on their hands grave mistake. I think they should have been out there doing deals. And you know, a lot of them were underinvested. Anyhow, they had a great deal of dry powder. They’re now even more under invested and they under are under huge you to invest. And, you know, ultimately a P house that doesn’t get money to work is no good to anyone. Mm. So they will get their money to work. Unfortunately they may well end up paying too much. Now, usually private act is pretty good at avoiding those sort of cycles, as I said earlier, and, you know, they’re astute people, private act invest. So they’re very reluctant to overpay, but I sense that quite a lot of houses have got their back slightly up against the wall in terms of the pace of investing. And that’s not a comfortable place to be. And I’d much rather be in a situation where you take a year off. Things are too pricey. Conditions are too difficult. I won’t be investing this year. And then do twice your usual number of investments when times are good for investing.

Ross Butler:

Yeah. So you have that flexibility, which is an advantage. We come back to maybe the structural advantages, but you mentioned you were active in 2020. I mean, what’s your view of the market and opportunities out there?

Luke Johnson:

Well, I’m very much to niche investor. So, you know, I’m not putting a hundred million to work a go or 200 million, whatever it might be, you know, I’m investing five, 10, 15 million pounds in each bet. And I think in the end of the market that I tend to operate in, there are opportunities two or three of the deals I’ve done in the recent past have been distress. And there’s obviously some of that going on, particularly in some of the sectors I’m familiar with. And those are deals that the vast majority of private equity houses are not geared up to do. Don’t feel comfortable doing for all sorts of probably good reasons.

Ross Butler:

Um there’s not much experience of doing distress deals.

Luke Johnson:

No. I mean, there’re obviously a handful of specialists that only do them and some of them are very good and really I’m really impressed by the quality of some of those deal doers.

Luke Johnson:

But they tend to focus only on that. Again, they would tend to be doing slightly bigger deals than me. And some of the deals I’ve done over the recent past has been modest if any competition, which, you know, for most private equity players is very hard to achieve. You know, generally speaking, every single deal is got proper advisors and intermediaries and is well marketed. And you know, the, the assets touted widely around the market and there’s plenty of competition and you get a, not a perfect market, but a pretty good market price achieved for most assets of quality and, and size. Mm.

Ross Butler:

Would you say that so I’m just trying to get to grips with what the secret of your success is. Would obviously you can’t put on a, on a napkin, but I’m wondering if to what degree would you say you use your intuition when you are assessing whether something is a good opportunity versus bringing in the advisors and producing reports for, you know, like, so a typical investment executive would then have to go to an investment committee and it would be a group decision, but it would also be a real discipline in terms of dotting all the eyes and crossing the Ts and making sure that there is a really explainable, calculable case. You don’t have to do that. So you can rely more on your intuition, to what extent do you?

Luke Johnson:

Well, I think having the discipline and having group input is vital. And you know, there have been occasions in the past where I have not been as rigorous as I should have been, not within our fund, but with my own money. And sometimes it’s blown up in my face and I, you know, I’ve tended always to be at the sort of higher risk, higher reward end of investing. So, you know, I’m much less interested in steady investments that will, you know, gradually make me twice my money. I’d prefer to go for things that make me three or four times my money, but occasionally go wrong and you lose everything. And obviously that’s highly undesirable and never part of the plan, but it can happen in life. It, it normally it doesn’t actually happen with deals. I do because of leverage it’s because the business hasn’t worked.

Luke Johnson:

I do use intuition and inevitably we are, you know, social animals who you mentioned at the beginning of this meeting, how much better it was face to face than on zoom. I completely agree. That’s all about what you might call intuition and being a human being I think private equity investors who pretend to themselves that it’s all science and spreadsheets are under an illusion. Hmm. I suspect none of them do actually think that because otherwise they wouldn’t be successful. No, I think having checks and balances is essential and they come in all shapes and sizes, not just credit committee, but of course, lenders and others will have their own, you know, impositions, I think relying exclusively on, you know, the accountants and lawyers and other specialist advisors to tell you all about the business, rather than doing any of your own personal due diligence.

Luke Johnson:

And having at least some in-house capacity of taking a commercial view on a situation and the people running it and so forth is a mistake. And you know, I have to say having worked with some bigger PE houses, some of them are very good at all that both having in-house resource, but also getting incredible work from advisors. So I wouldn’t to cry any of that at all. I think it’s important not to bely obsessed about the reports. I think you have to look at the big picture. You, you almost certainly, at some point have to take a view. I think sometimes, you know, I’ve seen PE houses miss a deal because they let relatively small issues cloud the thing, and someone else is more willing to step back and say, you know what, nothing’s perfect, good enough. I like it, etc. And it’s the right price and so forth.

Ross Butler:

Um you mean, a bias towards optimism to some degree?

Luke Johnson:

I think anyone in capitalism does. Yes. You know, if you don’t believe in growth and you don’t believe in a positive future, and you don’t believe in the potential of the business, you are backing to deliver value, then you probably shouldn’t be taking money on it. So yes, and I think probably ultimately most PE houses have that frame of mind or the individuals working in them. And so they should and obviously, you know, as well as making a turn on the multiple and the magic of leverage, the other biggest element in any private equity successful investment is growth. That’s the thing that will ultimately deliver the really great return growth. And indeed, it’s also what the buyer at the other end looks for. You know, I have occasionally invested in businesses that have very little, if any growth and they’re quite hard to sell because, you know, people don’t want to really invest much in stagnant businesses. And why would they, you worry that if he’s not going forward, he’s probably going backwards.

Ross Butler:

Yeah. You alluded to the fact earlier that you invest in relatively small deals and so they can be the specific situations that you’re assessing, but particularly I’d say at the moment, is it not increasingly important to take a more of a macro view as well, given the interventionism, let’s say of the state in various sectors are you having to, are you trying to factor that in, when you look at new businesses in areas that could be locked down?

Luke Johnson:

Well, it’s a very serious point and pretty profound for anyone who’s involved in markets and free enterprise and so forth, you know, have the rules of the game change such that the government will force you to shut in a way that would never in modern history of happened before and, you know, destroy the value you are trying to create here. I’m sort of without being ostrich like about it, I’m of the view that these are things one cannot influence, and generally, therefore you can, you know, give yourself a hashtag stressing about them all night long. I think you have to try and focus on your own specifics of situations where you can make a difference both in your own life and your business. And I guess I’m taking a view generally that, you know, with regards to, for example, lockdowns, which have been impacted certain sectors, like travel very severely indeed, ultimately society can’t afford many of these more.

Luke Johnson:

They’re just too expensive, both economically, psychologically socially. And so you know, the harms, the undoubted damage of lockdowns are becoming ever more apparent as was obvious because they’re diverse and long term, whereas of course, daily hospitalizations of and deaths from COVID to, you know, on a daily basis. But you know, governments can’t keep printing money. I don’t think in the way they have done to pay the bills. And you know, some of the bills for both businesses and governments are starting to fool you we’ve got threats like inflation. So and so on. So big picture means I don’t think, you know, countries like the UK and many others can really afford to do many long lockdowns let alone the fact that I think proof will recently show they don’t make much difference. So they really aren’t worth it, both health wise and wellbeing as well as economically.

Luke Johnson:

And therefore I think, you know, it’s probably a pretty good time to take a view and say obviously to a large degree, thanks to vaccines, but also the, the terrible costs of the interventions are such that they cannot be repeated again and again. And so as people keep saying, we have to live with the endemic disease and get on with work and, you know, start earning some money to pay the bills, which means decent businesses that might be shut down. If there were another lockdown are probably a reasonable bet, but there’s gotta be a discount somewhere in there. And, you know, clearly if once constructing portfolio, you don’t want to bet exclusively on businesses that are vulnerable to being shut down. And I know one or two PE houses where, you know, big chunks of their portfolio have been closed for much the last 18 months. I’m very lucky and is absolutely luck that I’d sold a whole raft of businesses over the previous couple of years, which would’ve been smashed to pieces by lockdowns. And thank God I did, because it meant that although I did have certainly a couple of businesses that are, you know, in sort of recovery mode, we say having been severely battered if I’d had a half a dozen of them, it would’ve been significantly worse.

Ross Butler:

Yeah. I think you’ve gotta be right to just focus on what you can influence. And yeah, I do find it surprising that there’s so little commentary on the potential fallouts, like economists used to issue, press releases. If we had a public holiday telling us how much it costs the British economy, and yet we’ve been impartial lockdown for two years and well, they don’t issue, press releases about it generally. It’s like, it’ll be all right. We’ll just go along as, as if nothing ever happened. So I think, I think you’re right. You have to just focus on what you can, what you can influence, but there probably will be a reckoning.

Luke Johnson:

Well, I think there needs to be reckoning because I think overall it can be argued that, you know, in certain ways society slightly lost its marbles over the last 18 months. I think the toll across many aspects of communities in terms of, for example, children and education, young people, generally, the damage to them the irrationality and lack of evidence base for some of the interventions and so forth and so on. You know, we don’t want to get distracted into that black hole. I is such that you know, in hindsight, in the years to come, I do think we will realize that grave mistakes have been made and I’m not talking about, you know, locking down two weeks too late. I’m talking about the very essence of universal lockdowns and the harms of, you know, unemployment and you know, the, the divisions it creates in society between those who have to still go out to work.

Luke Johnson:

And those who think that everything now is working from home for forever speaking personally, one of the toughest aspects has been, people thinking in a rational way when they’re all isolated. Yes. And I think for myself, and I believe for many others that actually you get things more right if you are debating it with others in person. Mm. And I think the idea that we’re all thinking rationally because we’re on zoom calls is diluted. I think there are very profound differences. I know for myself, I’ve had hundreds of zoom board meetings and such like, and I can tell you now they are very, very dysfunction compared to a proper board meeting with people in the room. Definitely no question of it. And for example, if you’ve got a large board and most large organizations and institutions have large boards, there is a massive predisposition towards people, not dissenting of any kind, when there’s a certain number, people on a zoom call, they are much more likely to stick their hand up or nod to the chair or do whatever it is to say, yes.

Luke Johnson:

I just wanted to bring up this one point. Can I just question this it’s extraordinary, how often a non-executive argument will do that and then two or three others will say yes, yes. I was wondering about that does not happen on zoom calls. Yeah. And you look at our leadership and the key advisor groups, for example, you know, in public health and others that have been making these draconian and extraordinary decisions all on zoom, not good debate, not good vigorous discussion of what are the, you know cost benefits of this. Have we thought of the whole picture here? Mm. And I think that’s been going on a great deal. And I think because we’re all snug at home, particularly those better off powerful people who run society in industries like private equity. The fact that, for example, you said at the beginning of this meeting, this is the first time I’ve had one of these interviews for 18 months. I can’t tell you how many conversations I’ve had like that, because I’ve been in my office and meeting people if I possibly can since May last year. Right. But every banker, every accountant, virtually every institutional person I know of fund manager, PE executive has been at home the whole time. And I don’t think that’s conducive to critical thinking. And

Ross Butler:

It’s so easy to say, well, what’s more efficient, you know, everything

Luke Johnson:

It’s convenience. Yeah. Convenience. Yes. You’re right. Efficiency is the wrong word because efficiency suggests getting it right. It’s convenient. It’s a bit like getting home delivered food. It’s very convenient, but mostly eats. I’d rather eat in a restaurant or have proper cooked food at home after you’ve done some shopping, then a crappy meal that is probably more expensive home delivered.

Ross Butler:

And yet it’s harder to articulate the benefits cause they’re slightly intangible and they they’re harder to, to put hard quantification on. And you also kind of alluded to the, everyone talks about quality these days, but there is a real inequality element to this whereby white collar workers like you and I could choose just never leave our homes again.

Luke Johnson:

Ft and economist readers love it all. Yeah. Because they run the world and they’re very comfy. They’ve got gardens. Someone collects the rubbish. Someone delivers their food. They, you know, get stuff on Amazon. They might see more of their family. What’s not alike and they’re safe. Meantime every year, every day in Britain, 10 million people are having to go out to work, to keep the broadband going and to deliver the groceries and so forth. And that is a more pronounced inequality on many levels than I think ever in our lifetimes. And you know, there are so many serious issues arise from this such a for example, has furlough undermined a chunk of the portions of the nation’s work ethic, you know, and it’s peak 9 million people being paid to stay at home. Why wouldn’t they want that to continue? Is the real reason people are willing to accept low quality output from working from home because it’s saving the money on commuting. I think that’s a big factor as to why lockdowns have had such enormous support seemingly. It’s not the science it’s because people are saving money on their fairs.

Ross Butler:

What’s your policy preference with regards to the companies that you own?

Luke Johnson:

Well, I want them in the office now it’s obviously up individual bosses. I would say, you know, if they think they can run things efficiently and you know, it makes more sense for their particular shape of their workforce to do it at least partly from home a hybrid model, flexible. I get it. And I think workforces these days will increasingly demand that and companies that insist everyone is in the office every day may struggle to recruit or retain people.

Ross Butler:

Although young people might find it more attractive.

Luke Johnson:

Of course. And I know I do. And I think there are, it depends on the big and the industry and the people in the work. UI guess people in my generation are much more likely to say, we’ve all gotta be in the room. Those who are, you know, much more used to the flexibility, should we say video conferencing might argue, no, let’s stick to what we’re doing now. And of course there are lots of things that can be done perfectly competently online rather than in person, but when it comes to anything critical, a key pitch or, a key sale or, interviewing someone to hire them or whatever it might be that really matters, then I see there is no substitute for doing it in the room. And, h passionately believe that. And I think actually it has been a competitive advantage, I believe over the last year in doing stuff that I am in the room when people are willing to be. And, h think it’s helped clench deals and given me an insight that people who are relying exclusively on zoom, you know, I’ve missed.

Ross Butler:

So the Woody Allen quote, which I’m gonna get wrong, but two thirds of success is showing up

Luke Johnson:

90%.

Ross Butler:

We’ll go with that. Leave us with something optimistic, positive. Can you tell us about deal you’ve got in your portfolio, you like the look of, or something about the world that you are optimistic about?

Luke Johnson:

Well to use that bogus venture capital phrase pivot, I have slightly towards areas that are more digital inevitably because historically, you know, I’ve invested heavily in areas like retail and hospitality, which means, you know, shops and restaurants and cafes in pubs and hotels. And of course, all of those, you know, have struggled over the last 80 months and face challenges going forward. So I would still invest in all of those sectors, but I’ve also made an e-commerce investment last year into a gardening products business it’s called Primrose. And that has an October year end, but we think it’s gonna deliver for this year’s results because it’s had the principal season now and we’re happy with that purchase. We bought it almost a year ago now. And I think it’s a good sector. And I think eCommerce in that space is growing gardening itself has boomed during lockdowns. And I think some of that will stick. And we are looking at further eCommerce investment because obviously it’s gonna take an increasing part of the market in terms of people’s overall retail spend. So

Ross Butler:

What’s primroses model. Do, do you have to go onto their website to buy their stuff or do they start.

Luke Johnson:

Yeah. I mean, you know, they have an app and so forth too, but mostly people are on the website and, you know, it’s, it’s exclusively, it’s not an omnichannel, so it doesn’t have any retail outlets at all. It only it’s, you know, only digital, and it’s quite long established business. And, it’s quite a fragmented sector. Actually. There are quite a number of digital players in, the overall gardening space. You know, it’s a sector that we stumbled across, but we like, and, I think there’s more to go for. So, yeah, I would say that was, a deal that we’re excited about and we think has, has lots of potential. And, and so inevitably, you know, if you look at e-commerce generally, you know, you are up against Amazon, but there are some sectors that they are perhaps less focused on. And I think gardening, you know, has some logistical challenges, gardening, for example, that Amazon seem less interested in. Right. And they’re such dominant player, ideally, you know, you don’t wanna be directly competing with them. Mm. We do work them actually as most people do in e-commerce, but, ideally you get people on your own website. Yes. And so yeah, that’s one business we’ve bought recently that, we think is interesting.

Ross Butler:

Great Luke. Well, it’s been great catching up with you in person. Thanks very much for sparing your time.

Luke Johnson:

Thank you.

Ross Butler:

You’ve been listening to the fund shack podcast, make sure you subscribe and visit our website@fundshack.com for many more video interviews. It’s the private capital channel for alternative investment professionals. Thanks for listening.

Alistair Lester, CEO of Aon M&A on protecting and enhancing returns

Fund Shack
Fund Shack
Alistair Lester, CEO of Aon M&A on protecting and enhancing returns
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Alistair Lester is CEO of Aon’s M&A and transactions services business in EMEA. This is not the conversation you think. Aon has spent recent years building out its capabilities across the risk spectrum.

Or watch the video version here.

 

Transcript

Ross Butler:

Alistair, you are the CEO of Aon’s M&A business in EMEA, but it’s not your first bout there. You started in the graduate scheme some 25 years ago, and in the mid 90s working for private equity clients. And I wanted to start by asking you to what extent has the insurance services industry over that quite long timeframe responded to the pace of change in the world and the risks that businesses and private equity firms face today?

Alistair Lester:

There’s been a huge amount of change of course, in the world. The insurance industry is not renowned for being particularly speedy in terms of pace of change, but actually there’s been a pretty significant amount of change within the insurance industry and particularly within the part of the insurance industry and the broader professional services aspects of our world that faces off to the M&A and private equity ecosystem. When I think back to being told that what we did for private equity firms was a niche part of our industry and a niche part of a firm that I previously worked for.

Alistair Lester:

I think we, as an industry, are really only just starting to embrace the scale of that relationship opportunity in the same way in the last three, four, five years, a couple of good examples of what’s really driven that Ross. If you go back two, three years, if I said to a PE firm, what do you think of Aon, Aon could do to help you? They might say, I know you, we talked to you on the limited partner side, you’ve got a big investment management arm of your business, and we talked to them about LP investments, or you are an LP in our fund or, or they might likely have said insurance due diligence. And they might’ve said something more recently, this warranty and indemnity insurance, or as we call it in the US, reps and warranties insurance product,  which has genuinely exploded in the last four to five years in utilization in PE.

Alistair Lester:

And yes,  we do all of those things, but what’s really exciting for us is our ability over the last few years as our industries evolve, and as Aon has evolved to bring multiple advisory capabilities, multiple advisory work streams to life on the one hand and multiple or an increased number of financially motivated insurance instruments to bear on the other hand and much more sophistication and science around how we really do develop, deliver value in the portfolio. So when you have that conversation now with clients who’ve been on that journey over the last three, four years, they would absolutely recognize our industry. And particularly our firm, I think, has been leading the charge in areas like cyber consulting, in intellectual property consulting and advisory and valuation, of course, in risk and assurance in the broad set of human capital from retirement benefits, but also talent reward and compensation aspects of deals.

Alistair Lester:

Then on the instrument side, looking at the adjacencies to warranty, and indemnity insurance like loan contingent risk insurance, be that tax insurance be that litigation insurance we’ve pioneered a product called judgment preservation insurance. We’ve pioneered the ability to wrap insurance around your intangible assets or intellectual property. You can potentially use those instruments as collateral, which enable you then to access different forms of financing. So really the big change has been this institutional-industrial realization there is an opportunity to marry up what has traditionally been seen as a relatively lazy, perhaps enormous pool of insurance capital with all the parts of the capital markets and bridge the two in a way that drives value into private equity deals, because as you and I both know, private equity are just so hungry for what they call new technology and new ideas, and that’s been a fantastic accelerator for what we do.

Ross Butler:

Why is AON providing the services that it is providing? What’s the journey from your insurance services capabilities to the services that you’ve currently  just outlined?

Alistair Lester:

The world lives in a world of risk, and Aon as a firm is all about risk. We are a risk business. Insurance is an instrument that can help clients manage their risk. But what we don’t do is just deliver insurance products. We also deliver a range of advisory capabilities that help clients understand, identify and mitigate risk insurance instruments are just one part of the mitigation aspects of how you deal with risk. Every deal that any client does, they price risk into their deal, and they deal with risk in a deal in different ways. Maybe they priced chips. Price chips are a result of people identifying risks they’re not comfortable with. Maybe they seek contractual recourse against the seller against the counterparty, and maybe that contractual recourse is somehow secured through escrows. Maybe, as a buyer, if I identify risk in a deal, I defer an element of the consideration to see if that risk crystallizes, and if it does, I’ve protected myself because I’m not having to pay my deferred element of the consideration. All of those things are well-established approaches to dealing with risk in a deal. Those risks need to be identified for people to be able to understand them and then come up with solutions for them. So, the exciting point is we think those three buckets of price-chipping contractual recourse, and deferred consideration, they’re all perfectly valid ways of dealing with it, but none of them are actually optimal ways of dealing with risk in a transaction. By contrast, optimal approaches can include solving them through more insight into those issues, so you get more comfort with them. We can provide that in a range of ways across people, risk and cyber risk and intellectual property risk, et cetera, et cetera. But secondly, by introducing an insurance instrument, which can take that risk away in a far more attractive way and deal with those potential risks in a far more attractive way, potentially than price chipping or deferring, or getting contractual recourse against the counterparty.

Ross Butler:

And all of this kind of moves you further towards, I suppose, insurance being a purely defensive product. You’ve got a clear line of sight to enhancing returns through all of this.

Alistair Lester:

You’ve teed it up beautifully. So, we talk about what we do is securing investments and enhancing returns. That is our little strapline. We think with our advisory capabilities, we can give you much more insight into what you’re getting into. We think with some of the core traditional insurance solutions that are out there, very plain vanilla, traditional insurance solutions, you can secure that investment. But actually going to your point on enhancing returns, we think that we are able to deliver these structured insurance instruments across a wide range of areas, including structured credit and tax and litigation, et cetera, whereby spending a pound, a dollar or a Euro on that instrument you are realizing or recognizing multiples of that either in the enterprise value or somewhere in the capital structure of the transaction.

Alistair Lester:

That is a very different way to think about insurance, where for most of us, including people who live and breathe it, you know, renewing our car insurance or home insurance, or even our business insurance every year, what you’re really looking for is a way of reducing the cost of insurance, because you see it as a sunk cost. You don’t see it as a return generating instrument, whereas with a lot of what we’re doing, it’s spend a dollar or Euro pound on that instrument, and you will see a multiple of that somewhere in your enterprise value or capital structure.

Ross Butler:

It seems to me that risks over the, say, that 25 year period, have gone from being relatively tangible, relatively geographically, constrained to being much more intangible, much more distributed across the world, less physical and therefore just much more complex. And I suppose, as a result of that, harder to quantify and I guess where there’s complexity there is opportunity, which is why it’s logical for insurance providers to have expanded in this way. Is that a reasonable reading?

Alistair Lester:

I think that’s, that’s a very astute reading Ross. I think this is why Aon has diversified its capability set, for exactly those reasons, And if you double-click on intellectual property, as an example, and intangible assets, as an example, you only have to look at the huge rotation of the S&P500 over the last 40 years, which has gone from being, completely dominated by hard assets, tangible asset values, and companies who operated in those areas to companies, which are absolutely intangible asset rich and intellectual property based. And as a result, by the way, the insurance industry, some argue, has struggled to stay relevant as it could have done growth of global insurance premiums has lagged global GDP growth for that reason, because the insurance products are not as relevant as they need to be to what’s going on in the world traditionally. So, Aon made a move into intellectual property – and this is what Aon has done brilliantly – we have purchased capability and talent in adjacent areas to us. So, we bought a business, which was one of the leading intellectual property consulting businesses. And then what we’ve done is we have worked with that business to deploy that capability into a private equity context. We’ve worked with that business to build insurance instruments that can deal with intangible risk and intangible assets in a way that wasn’t previously being addressed. And we’ve gone one step further by helping to use both of those things, the insights and the capability we have on the advisory side, the risk modeling, the quants capability we have on the valuation side to then build product, which is enabling and opening the door to IP, rich companies, to access financing, using insurance as a collateral around their intellectual property in a way that’s never been possible before.

Alistair Lester:

So that’s an absolutely spot on. What Aon has done over the last five to ten years is it’s added inorganically areas of talent and capability, whether it’s in cyber, whether it’s in intellectual property, the talent world, we’ve added businesses and people who have bought different skill sets to our firm. Many of whom have had zero exposure to the insurance industry before. But actually by bringing these people into our industry, they are giving us perspectives on different emerging risks, which we’re able to support clients from an advisory point of view with, but also match those risks into the huge pool of insurance capital and start to build some new and evolved and developing insurance solutions that, that provide answers.

Ross Butler:

Tell me a little bit more about the, the IP services, in the specific context of venture capital and private equity. What type of business is it most useful for?

Alistair Lester:

So we think that one of the things we’re most excited about is we’ve always had a relatively limited story for the VC end of the private equity and financial sponsor community that is truly value added. We have an ability to identify, map and value the unique intellectual property, particularly the patents, but not just the patents, it can be data. It can be trade secrets, et cetera of individual companies. By doing so, we place a value on that, on that intellectual property, through a proprietary valuation methodology. We have the former head of intellectual property at Phillips in the Netherlands, global head of IP at Phillips. We have the former general accountants of general counsel for patents from Microsoft, right. People who honestly, if you ask them, ‘Would you ever, five years ago, can you ever see yourself working at Aon?’ They would have said, ‘absolutely not. Why would I?’ So we have some unbelievably deep talent in the IP space. I think we have more of the top 300 recognized global IP strategists working for Aon than there are at any other company in the world. And no one would know that right.

Alistair Lester:

We then spent a long time persuading the insurance industry of the efficacy of that valuation methodology, and there are many other parts of the capital market’s ecosystem, which rely on the underlying security of insurance to enable financing. We look in the aircraft, leasing space, residual value insurance on aircraft hall is, is a critical requirement for aircraft leasing. You know, finance use of aircraft leasing require certainty over what the, the aircraft may be worth at the end of the 10 year lease. And the way they’ve got that in the past is through residual value insurance that provides the underlying security, really what we’re doing and intellectual property is a similar thesis. We are valuing the intellectual property for a proprietary methodology. We then were demonstrating the efficacy of that valuation to the insurance market who are then wrapping an insurance policy around that value, not at a hundred cents on the dollar at a discount to the value, maybe 50 cents on the dollar by wrapping insurance security around what were previously intangible assets.

Alistair Lester:

You are turning them into tangible collateral. And what can you do with tangible collateral is you could raise finance against it. So, now we think we’re inventing or pioneering at least a new potential way for firms who are in the maybe series B series C stage to raise working capital and runway capital. Because up until today, the primary way for those firms to raise money has been to raise equity founders that owners don’t like raising equity, it’s diluted, it’s expensive, it’s painful all of those things and actually being able to, or they go and raise venture debt. And venture debt performs an essential service, but also it’s not, it’s got a lot of complexity to it. We think we have an instrument now, which can enable you to access pretty straightforward, not cheap, but pretty straightforward debt secured against an insurance wrapper, which is wrapping your intangible assets. And we think by doing that, we are potentially reinventing how you finance early stage companies. The British Business Bank wrote a paper probably two years ago saying why can’t banks recognize intangible assets more as collateral for financing? We think we are leading the answer to that question, which is- what can you do if you do it in this particular way?

Ross Butler:

I assume that larger businesses with large IP people folio, they’ve got other financing options.

Alistair Lester:

A hundred percent. That’s a great question. But, and yet, we also have clients who are approaching us and asking whether we can collateralize their IP portfolio for the purposes of satisfying pension trustees. Right. For example. So, you know, we need to provide collateral to our pension trustees. Maybe this is a product that we could use to satisfy our pension trustees over pension liabilities and future pension contributions. We’ve got financial institutions who are approaching us and asking whether this is a product that they could use to satisfy some regulatory capital requirements, right. So, you know, is this a product that could satisfy the banking regulators to a certain level that intellectual previously unrecognized intellectual property that they held in their business is now something they can collateralize and use to enhance their financing of, of whatever obligations they have. So it isn’t just the venture answer, but we’re seeing particular appetite and interest in the venture backed community in the early stage businesses area at the moment.

Ross Butler:

That’s a great example of allowing people to focus on the upside and enhance their returns. I don’t want to spend the whole time talking about COVID, but obviously it’s completely changed the nature of, and scale of risk. That touches on so many parts of business, so I’m thinking particularly like cyber, for example. I was speaking to a CEO the other day, he’s based in London, 90% of his employees are in India. Geographically remote. Can’t get out to them very easily. All of these risks seem to be not really thought of, just a couple of years ago.

Alistair Lester:

We launched our cyber- M&A private equity focused business, getting on for two years ago now. We did it for a couple of reasons. Outside of private equity and M&A, Aon had made an inorganic acquisition in a company called Strauss Frieberg, which was one of the leading global cyber risk consultancies that grew up in the US and again, I I’d imagine if you spoke to many of the people inside the original business, they had not had anything to do with the cyber insurance worlds. They were deep cyber risk consulting people. Then we built a client facing delivery of some of the capabilities within that business, and we did that by, we actually bought across people from the big four who were providing private equity, cyber due diligence, which was just emerging two or three years ago. We bought some of those people across. And the exciting thing is, we were able to persuade them of a couple of things, which I think we’ve proven out, which is one. We have the in-house technical cyber capability that we just bought this business with deep technical cyber risk capability. But two, we also have in our industry, a huge amount of data insight from cyber insurance. So we know what is happening in the cyber risk world, because cyber insurers are paying claims for our clients. So we know what’s, what’s creating those claims and we know how much is being paid for those claims and how those claims are being managed and how the risk of being mitigated to avoid them happening.

Alistair Lester:

Again, you put together deep cyber technical expertise with quant data, true deep, rich data over what is actually going on in the cyber world, which is causing financial loss. And you’ve got a unique skillset. So, our cyber team, actually very specific to private equity, have built something called Portfolio Scanner, a piece of proprietary tech, which blends in automated threat analysis with a quant model. We’ve done this for a number of PE firms. You can run it at relatively low cost, to come and run a six month cyber review across your portfolio. You can run it in very quick time, automatically across your entire portfolio, and it gives you a traffic light outfits of which firms in your portfolio need a closer, deeper dive from a cyber risk point of view.

Alistair Lester:

It’s no guarantee that there’s no problems in the ones that are green or amber, but it will tell you from an outside-in point of view, an unobtrusive outside-in points of view, where we think based on outside threat and industry sector knowledge and claims statistics from cyber insurance, you should be going to look Mr. GP to double-check that firm is doing what it should be around cyber risk. We actually ran that for a GP last year. And one of the firms that came out on the red of the traffic lights, we literally just reported to the sponsor. And just 10 days later, as we were going through the action plan, they had a ransomware attack. And that led into a huge recovery exercise. Again, no guarantee that if we ran that exercise six months earlier, the ransomware attack wouldn’t have happened, but certainly there would have been more awareness within that firm of the risks and, and hopefully some, some mitigating actions would have been taken.

New Speaker:

What’s really powerful areas that is all consulting work, but we’re delivering technical and rich data insight in an, in an automated manner, in a highly efficient manner, real time. We are launching and delivering within three to four weeks, not let’s run a long cyber risk consulting project, which takes many months because by the time the speed of the world’s changing so much that, you know, six, nine months’ time, it’s a different threat. It’s a different group of people. It’s a different type of ransomware, whatever it is, you know, you need to be keeping on top of this on a regular basis.

Alistair Lester:

So a lot of our PE funds now are actually running Portfolio Scanner on a regular basis, but at six months or 12 monthly, and they run it, it’s just a, it’s a health check across their portfolio. And it just helps them stay in touch with, with exactly what’s going on. And, you know, we were quite excited. We ran it for Cinven, which reported that in their ESG report.

Ross Butler:

That makes perfect sense to me, marrying the qualitative in the quantitative. I’ve long felt that you have the cyber professionals who are focused on best practice and process, but you’ve also got the kind of the unknown quantitative part, which is the elephant in the room. And you know, companies that pay ransoms, they don’t publicize it, of course. And one suspects that it is a much, much bigger problem than most people realize had they had to send a press release out and it was in the media. And so there’s something of a disconnect between the scale of the problem and what to do about it. And it sounds like you’re able to contextualize the problem and then find the solution, which feels to me like where I’d want to be.

Alistair Lester:

Yeah. Yeah. Look, I think just one thing I’d add is, is I’ve just talked about that in a portfolio context, which is critical. The other thing we’re learning is fascinating is our clients who go through that exercise, looking inside the portfolio, across the portfolio, they almost without fail, ensure they implement pre-investment cyber due diligence as a specific work stream going forward. A lot of firms haven’t been. Or they felt that their IT DD covers cyber. They’re close cousins, but they are distinctly different things. By the way, we’ve also got to make sure we’re okay as we’re going into new deals and this whole workstream of cyber due diligence, which we think where that evolving further into what we call digital and tech DD, where you’re looking at yes, the cyber risks.

We had a client say to us not long ago, every deal is now a tech deal, right. So let’s look at the tech in that business and understand how risk-exposed it is. We just brought a guy in from Turner & Townsend, a well-respected property consultants. Again, not an insurance guy, he’s a risk consulting person, but he’s able now to deliver his risk advice in a much more informed and contextual way because of the data and the insights we can provide from inside the industry. And that’s why we’re bridging the advisory and the risk transfer together.

Ross Butler:

So just so I’ve got the lexicon straight, you’ve got it, diligence, which is like you, your internal systems, and processes, and making sure that they’re efficient and functioning. You’ve got cyber, which is like security and stopping attacks. And you’ve got digital and tech, which is

Alistair Lester:

It’s performance risk. We ran a deal for a PE fund who was buying a, a reasonably well-known real estate platform. Right. And actually what we helped them understand was how many of the hits on the platform were from bots and how many were genuinely from independent consumers, right. And that goes to value. You want to pay for the consumer. So it starts to become not just a risk issue, but also evaluation issue, which is exciting.

Ross Butler:

What about people risk? Do you do anything in that domain? Obviously there’s a link with, with cyber and behavioral behaviors.

Alistair Lester:

We do it very broadly. And I think traditionally again, when people thought, well, what would Aon do in the human capital space to help us? It would be, well, we’ll do some actuarial work on the pension plan, or we’ll do some look at life and medical insurance and make sure that we’re meeting employee benefit risk. But again, Aon bought a business not long ago called QT, now rebranded Aon Assessment Solutions, they are a bunch of psychiatrists and psychologists. We had an infrastructure client who was funds, who was buying a, a bus business. I mean, lots of infrastructure funds by bus businesses. I think EQT had just bought a big one in the US.

New Speaker:

Interesting little story: we were arranging motor insurance for the bus company and they have to have it. And one of the things that drives motor insurance is, is driver’s safety. The price of motor insurance is driven by how safely, how well do you train your drivers. We brought in our Aon assessment colleagues to create a framework for the type of personality that they wanted to hire and to maintain as bus drivers and to put it very crudely, you are looking for people who are less aggressive on the accelerator, on the gas pedal. There are characteristics which are going to lend you to be more heavy or less heavy on the gas pedal. So that had two incredible benefits.

Alistair Lester:

One: By doing that, and by demonstrating to the insurance company that they were hiring that sort of person that puts the risk in a better light, it enables Aon to secure a better price for the core old-fashioned motor insurance for the buses. But here’s the other thing you could also demonstrate: how the fuel consumption of the fleet would reduce and the environmental positive environmental impacts. And of course, the economic positive impact in terms of reduced gas fields and fuel bills for the bus fleet. You’re going to value in way more ways than just one, which is we can help you reduce your insurance premium. We could also help you reduce your operating costs through reduction of fuel consumption, and we can demonstrate that you’re thinking about that through an ESG lens in a world where those things are increasingly important. It’s a really good example of how we’ve gone from being an insurance broker to adding these other elements to a value.

Ross Butler:

And that comes from presumably the psychological profiling of the people

Alistair Lester:

Right. So when you go and hire now bus company, you need to hire people with these characteristics, which we have defined for you, and it’s now built into your, your recruitment processes.

Ross Butler:

There’s a huge change that’s, that’s happening in terms of the work environment. Are you’re doing some thinking on this area.

Alistair Lester:

So again, we have an enormous human capital practice who stretch right across, you know, governance, board consulting, compensation, talent, et cetera. And, and we have, we’re one of the firms we sponsored in various countries, something called the Work Travel convene. So we brought together in Australia, in the US and the UK in different countries, large employers. And we’ve done that over the last 12 months. And this isn’t, you know, the private equity and M&A world, but this is more broadly as Aon. And what we tried to do in the private equity community is then bring the conclusions and the insights that, that are being created from those sort of exercises into P funds into their portfolio. But the work travel convene is really trying to look in that crystal ball about where this is going, what are the implications for the workforce?

Alistair Lester:

One of our big areas of course, is terms and conditions of employment and benefit packages, and how do you construct compensation packages to reflect different working environments and all of those sorts of things. So a huge amount of work in progress on that. And I think a lot of clients are increasingly looking for help in that area, because as you say, there’s so much uncertainty.

Ross Butler:

Yeah. I think also private equity firms are increasingly focusing on people and talent and talent retention is their core asset. And you’ve got private equity firms hiring HR, internal HR people to just think about that within the portfolio.

Alistair Lester:

Again, one thing that people won’t know probably is Aon has two businesses, one called Radford, and one called McLagan. They are two leading compensation consulting and compensation data businesses. In fact, McLagan is probably recognized in the general partner and the, in the PE community as being the leading private equity compensation consultant in the world. We know we build many of the, many of the maps, many of the GP carry plans, they come through McLagan insight, but again, Aon in the past culturally McLagan would have been run as a very independent business, delivering his value to its clients in a, in a slightly isolated way.

Alistair Lester:

The way that the firm has been reorganized in the last few years is, is around what we call Aon United which is really about bringing the whole of the firms and the clients, and the fact that we have people who are delivering compensation and talent advice to a large number of PE funds, you then think about how can you maximize compensation particularly through carry of your general partner practitioners through the ever-increasing adoption of innovative solutions and innovative financing structures, right? So those things are linked as well. We can help you maximize returns in your portfolio companies, which then drive your compensation structure that we’ve helped you put in place by the way, through these ideas over here. So, these things are not all individually separate from each other. They are all intertwined.

Ross Butler:

I’ve got a couple of other COVID things on my list. Supply chains, which I assume is bread and butter for insurance services, but global supply chains, given international relations and protectionism, is, it’s not in a good place.

Alistair Lester:

That’s a critical factor. One of the most important parts of the insurance world, which is probably overlooked is two areas, but one is business interruption insurance. That’s come under the real spotlight as a result of COVID. I mean, let’s be honest and, and not necessarily the most positive spotlights, and we’ll see how that all plays out, hopefully positively for policy holders who have valid claims. People in our industry have been talking about supply chain risk for a long time. I think what COVID has done is accelerate that and now there really are needs for firms to really, truly understand their supply chain, but not just because of the, the revenue and the, and the financial risks, but also increasingly through an ESG lens as well, you know, modern slavery background checking, all of these sorts of things are really important in the supply chain.

Ross Butler:

I’ve written a couple of things down from your preamble, but I can’t quite read my writing. Judgment preservation insurance. Is that right? Yeah.

Alistair Lester:

So that’s a, that’s a new area we’ve developed over the last year or so. So we’ve invested heavily in, in our litigation risk group. So there again, there is a theory, a thesis that we would like clients to see litigation as a potential asset, rather than just something they unfortunately have to go through. If you’re bringing a claim against somebody and you believe you’re going to win. And more than that, perhaps you’ve won at the first quarter or the second court. We developed a product which will enable you to ensure as much of that judgment as you can. And in the event that it progresses to the next layer and you lose, then the insurance, it provides you that, that capital. And here’s the thing that that’s really exciting. So we just closed the deal for a client who had won a significant judgment against the large US firm. And we were able to secure several hundred million dollars of insurance, which by the way, it was not the total amount of the judgment award. It was a substantial tranche of it, but by no means a majority, we were able to secure some, several hundred million dollars in judgment preservation insurance, which very simply said in the event that this is overturned, you are going to be indemnified by the insurance company, and that’s nice to have, right. But here’s the really positive and interesting thing: that firm was then able to use the judgment preservation insurance to access third party financing. So the insurance became collateral to access financing. Litigation funding has become a big thing, right? Litigation financing has been around a long time. It’s absolutely got a place. It provides a very essential service. But we are introducing new ideas, which potentially are alternatives to that, arguably again at a lower cost of capital. And that’s super exciting. We’ve hired people in our firm from litigation, funders and litigators who understand that world. And what we’re really doing is using their knowledge and insight with our capability of building insurance, structured insurance instruments and structured products to, to redefine how, how clients can, can see, find value in those sort of situations and see them as assets.

Ross Butler:

In a private equity context, every moment counts, it’s the distraction, I would imagine more than anything, you don’t want it as a standing board item, when you’re trying to grow a business fast.

Alistair Lester:

This is exactly right. And certainly when you come into exit, right, what you do not want is uncertainty over litigation and exit. So we do a significant amount of wrapping up litigation like we do within the tax world. What insurance is very good at Ross is, is rapping, is bridging low probability, but high financial risk situations into certainty, right? And of course that costs money, which is the premium. But that’s what insurance can be very good at. And if you can, you can do that increasingly with tax. Some brilliant advisors around the world will tell clients, this should be fine. What you get from the big four, what you get from the lawyers is we’ve done this before. This should be fine. What you don’t know is whether someone on the other side of the deal table to you has the same view.

Alistair Lester:

Maybe they are a large conservative, strategic, maybe it’s the first time they’ve done a deal in that jurisdiction, whatever their motivations are for feeding the risk, the perception of the risk is different to your perception of a risk. And those are the sorts of things that can derail deals, right? They can get, they can, they, you know, they, they become distractions from actually, this is fundamentally a good business. We want to buy here, but we’re getting distracted by negotiating and arguing over whether we think this one piece of litigation is more or less likely to happen or more or less likely to cost this amount of money, right, and insurance can deal with those situations by giving you a well, we can sell you, it will cost you this to take this issue away. Now, all of that cost makes sense in the context of the data.

Alistair Lester:

It doesn’t, but at least it gives you something, a point of certainty, which you can get a resolution on and that’s becoming much more understood and that’s relevant in tax too. And you can push further by the way, without getting too off piece into further adjacencies around structured credit. So the same broad thesis Ross applies in receivables financing. So one of the things COVID has done is really drive a real increase in the amount of receivables financing that go on in the market. What many don’t appreciate is if you can wrap insurance around those receivables in an appropriate manner, you can de-risk that portfolio receivables. If you’re de-risking that portfolio of receivables, you can arguably lengthen the tenor and reduce the coupon on the financing terms you’ve got. So it’s the same thesis. And just in a slightly different situation.

Ross Butler:

So do you have a classic CEO 3 or 5 year vision for Aon in M&A?

Alistair Lester:

I do. We’re living in the middle of the hottest market we’ve seen in, in a long time. We’ll see how long that lasts. But I think, I still think we’re scratching the surface in terms of the value we can bring to our clients. If I’m really harsh on ourselves, we still are delivering one or two of our core traditional value propositions into a deal. And actually if we just paused and, and delved a little deeper into the deal or had the right conversation in the right way at the right time, there are multiple live opportunities that we have allowed our clients to leave value on the table because we haven’t been either able to identify or able to articulate how we could find a way to help them to, to find that value and bring that value off the table. So that’s really the key thing. I think we’ve grown enormously in the last three to four years. There is still huge white space for us, we think because there’s just, we’re very fortunate. We’ve got an incredible breadth of services and we’re backed up by this incredible ability to bring capital, to bear in a way which hasn’t happened before. And honestly, we’re scratching the surface.

Ross Butler:

Alistair, thanks so much for your thoughts and for coming on to Fund Shack. 

 

Alistair Lester:

Listen, thank you so much for having us Ross. It’s been great.

 

#23 Simon Witney on sustainability rules and corporate governance

Fund Shack
Fund Shack
#23 Simon Witney on sustainability rules and corporate governance
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Subscribe on Apple Podcasts | Spotify 

Simon Witney on sustainability and corporate governance.

In this episode, I’m speaking with Simon Witney, who’s probably the best known private equity lawyer in Europe. He’s currently a senior consultant at Travis Smith where he spends much of his time advising clients on sustainability. He’s been chairman of the BVCA’s Legal and accounting committee and Invest Europe’s Tax legal and regulatory committee. He is a visiting professor in practice in the law department of the London School of Economics, where he teaches.

And he has a new book out published by Cambridge university, press called Corporate Governance and Responsible Investment in Private Equity. Our conversation is in two parts. Firstly, we look at the new sustainability regulations and what they mean for companies and investors. And then we go on to look at corporate governance itself.

You can watch the video version (with speed controls and bookmarks here.)

Enjoy!

 

#22 Carl Bradshaw, Goodwin

Fund Shack
Fund Shack
#22 Carl Bradshaw, Goodwin
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Subscribe on Apple Podcasts | Spotify 

Carl Bradshaw is a partner in the law firm Goodwin’s private equity group. He has advised European, American and Asian private equity sponsors on cross border LBOs, public to privates, co-investments and special situations.

We talked in late March 2021 about deal appetite going into the second quarter of 2021 new deal-making processes and the rise of the special purpose acquisition company. You can watch the video version (with speed controls and bookmarks here).

Ross Butler:

You’re listening to Fund Shack. I’m talking with Carl Bradshaw, a partner in the law firm. Goodwin’s private equity group. Carl is based in London and has advised European American and Asian private equity sponsors on a wide range of transactions, including cross border elbows, public to privates co-investments and special situations.

Carl, welcome to fund Shack it’s mid-March and restrictions are slowly thawing away in Europe, fairly slowly in the UK though. How are you seeing the private equity market from a transaction perspective? And how would you characterize sentiment at the moment?

Carl Bradshaw:

Yeah, so Ross we’ve been sort of in this state however you wish to describe that for nearly a year now, the conclusion that we can say is that the industry is certainly resilient is certainly adaptable. Absolutely. There was a rush this time, last year for people to focus on keeping people safe and you know, wrapping up their portfolio companies, frankly, to all the things that were going on, making sure they had enough liquidity to survive initial shutdowns and lockdowns but very quickly people that to operate in this environment, whether that was, you know, using technology to get deals done, to meet people, to talk and look and evaluate or, or just in terms of actually finding opportunities. And you know, within months we were back into transactional activity certainly in, in, in the middle market where you had, but it’s a combination of processes that had been put on hold that were sort of pushed through and we’re ready to come to market either just to close off remaining elements or, you know, from start, start to finish, we saw that.

Carl Bradshaw:

And then you had a sort of new wave of, of deal activity where it was either very technology focused or very healthcare focused. And that has really sustained itself through to, through to now. I think obviously in, in some sectors, there’s, there’s been a pause and people are waiting to see what the vaccine does, what the government support measures do and when, and how they get withdrawn in order to assess sort of investment appetite. And obviously we need to see how consumers react, to those measures as well. But certainly in certain sectors, the market’s heating up and we’ll say pretty buoyant buyout activity, whether that’s funded through equity checks from the sponsor directly, or backed up with debt either coming in from, from still, still the bank, but increasingly so from the credit funds yeah, it’s, it, it sent me that to be seen. And in some cases we’re seeing some really competitive situations, but for the assets in the sectors, I mentioned that, you know, people want to, to deploy capital into

Ross Butler:

Those sectors, presumably being tech, healthcare.

Carl Bradshaw:

I think those are it certainly as you get into the middle market and, and above at the lower end, you’re seeing some life science you know, as a variation on that, on the healthcare theme. And even, even within technology, I think it’s, it’s not everything not everyone’s sort of pouring money into driverless cars. I think there’s been some quite a lot of thinking has been done on what segments are going to be most robust and have proven themselves most robust three, three dash periods, enterprise software, data analytics, and things of that nature are certainly still, it’s still very popular with, with PE sponsors.

Ross Butler:

It’s increasingly difficult to think of tech really as a sector in sofar as pretty much every business has. It is having to deal with some kind of tech enabled conundrum right now.

Carl Bradshaw:

Yeah, I think, I think that’s right. I mean, there’s, there’s often been a hesitancy for private equity to to market themselves as being into the tech sector. Right. And I think people, investors into be fathers might be a little bit scared off by some of the very high valuations that you see in the tech sector. And whether that growth the businesses like you, you have the opportunity to invest into is going to be sustainable. You know, other there’s other features of the tech sector, whether it’s the dynamics with founders and entrepreneurs or you know, the, the, the lack of the excellence of process that P has really become accustomed to that has stared at people traditionally away from deploying lots of private equity capital into that sector. But you’re right. I think it would be inaccurate to just group group all of the different segments in, in the same bucket.

Carl Bradshaw:

I think private equity has come around to the idea that yes, technology is in all parts of our life and tech enabled businesses means need to sort of find capital in order to grow in order to survive in, you know, the, the most dynamic areas of the economy today. So yes, there’s more and, and also, I guess there’s been some good good examples of success in that area, whether it’s fish there or Thoma Bravo or Hg, people have gone there, have taken the plunge in and done very well after that. So, certainly there’s no there’s not the same hesitancy as there may have been 10 years ago to, to invest in that area.

Ross Butler:

It’s strange given that their venture capital cousins live and breathe technology, I think Goodwin’s sometimes operates at the intersection of venture capital and private equity from what I’ve read.

Carl Bradshaw:

Yeah, very much so. I mean, we, we see that as our sort of strategic priority is to be as close to those two worlds as possible because we’re only seeing convergence and not divergence. And I think the, the peas are moving down into that space. One to just get smarter on technology and the pace at which it is you know, transform, transforming business. And they, they want to get an early early look to, I think the P exits or venture capital backed businesses exiting to pay. It’s just becoming more and more common. And I think even, even you know, in 2020, we sort of doubled on the amount of PE exits that were there the year before. So it is an area that people see that the opportunity, and I think getting, getting smarter is, is definitely something that is high on the agenda for our clients fit for Goodwin. We just say as part of the lifecycle model that we’ve tried to build around companies from a very early stage three, all the way to where they’re going through a strategic process, be that M and a selling out to P or, or going through it to the problem,

Ross Butler:

Going back to lock downs. Has anything changed in terms of the process of doing deals in the last year that you think possibly might end year in the, in the longer run? Yeah,

Carl Bradshaw:

I think, I mean, the obvious answer to that is travel. I think people will get on fewer planes and meet in person on a, on a less frequent basis. I don’t think it will go all together. There’s definitely a lot to be said for I guess both the, both the engagement that needs to be had between a management team and its potential new sponsor to, to get those people together is going to continue to be important. And I think, you know, people, people that are, that I talked to on the investor side are just, you know, itching at the opportunity to get in a room and have those conversations with the management teams or prospective management teams, I think on the advisory side whilst we’ve been efficiently through, you know, remotely and three screens definitely when it comes to getting things done, we would say some, some speed gains and just general sort of ability to get things over the line by being in the same, in the same room with each other.

Carl Bradshaw:

So I do see that coming back, but certainly the use of technology based on the outside intelligence begins early and has been happening from people’s bedrooms or studies, you know, for the last year that’s, that’s definitely a game to enjoy. And, and Adam was already the case, to be honest, there was a lot of technology starting to get deployed in whether that’s through data rooms, whether that’s through you know, the legal technology we use to sort of save street contracts and spit out findings. I think that that has accelerated over this process. And so we’ll certainly see, see that remain whether the remote what I’ve heard of virtual drones being used to do physical inspections, and obviously that, that saves some costs. And if you’re not fully committed on doing the deal, you might, you might think about that. But I think getting people together and on, on the ground is probably gonna come back as, as soon as it can.

Ross Butler:

It’s funny. Cause most people took a technology in terms of efficiency gains, but I guess was something like, you know, the, the classic late night deal negotiation high, it’s a highly collaborative exercise I assume. And just being with people is probably preferable, maybe even less tiring, even if it is late at night.

Carl Bradshaw:

Yeah. I see you had this, let’s not forget the psychological aspects of doing a very demanding job on it, on a deal. Yes, absolutely doing it physically in person with others helps. But yes, just, just getting through that process. I think what we’ve seen is whilst as, as well thought through, in as structured as they possibly can be in this very uncertain environment, there they are generally taking longer just to, to execute and getting, you know, getting the answer from someone who’s not knowing the room, we’ll just take extra time. And then in putting that to a conversation that moved on three or four paces can be difficult. So yes, I think that there’s merit to getting people together, certainly from, from our perspective as a, you know, we’re very much in a Prince trip culture as having people around from the outset of their careers that they can learn and see how these things are happening, I think is, is an important aspect as well.

Ross Butler:

Has anything changed in terms of contracting given the advent of lockdowns, I’m thinking, you know, provisions to give buyer’s assurance is that of thing.

Carl Bradshaw:

Yeah. So there’s a few sort of pieces of that, I guess. Initially there was great concern about, well, you know, the certainty of a deal actually happening. So if you had the leverage on the, on the buy side you would want, you know, potential out to the deal, if the lockdown or some sort of pandemic related aspect made for a materially different investment proposition and the one you thought you were signing up to three months earlier. And so certainly those conversations have been had, I would say by and large because the market is still very much, you know, lots of capital to deploy low interest rate environment. Sellers are invariably resisting those sort of deal uncertainties that you know, but that gives the buyer the right to walk away or renegotiate the deal. So that, that’s definitely one aspect that there’s been more conversations around and it very, very much turns on the sort of dynamic of a buyer and seller in any given situation.

Carl Bradshaw:

I think Ben, in terms of due diligence, your you’re seeing more scrutiny placed, not just on the underlying sort of the business and how compliant it’s been during this period, whether that’s the health and safety aspect of how it’s looked after its people or whether it’s made use of government support measures, you know, furlough schemes, deferral of taxes government loans, in some instances, you know, there’s, there’s definitely a lot of sensitivity to make sure businesses got that right, or where they haven’t, where when you remedy can be can be pursued. And then as I saw, aside from that, I think investors are looking through these businesses and out to their end customers, right? So instead of just supply to supply chain continuity, which has always been important, but come under the spotlight in the last 12 months, people are saying, well, you know, is that supplier or is that customer, what, what’s their solvency situation?

Carl Bradshaw:

Are they going to be able to continue? Can we get access to that information and diligence and evaluate it as part of this in entire cycle? So yes, there’s been a number of changes, but at the same time, it’s very sector specific. I think in the, where there’s competition for assets, we’re seeing very similar treatment given to businesses. You know, we will look at the financials, we’ll take the ties on the accounts. We will take a a large amount of comfort from re-investment on the part of the management team into the new deal. We will rely on insurance as far as possible, and we will present in a competitive auction, a very contract, but you know, the salaries are not going to have to do much thinking about as to whether it’s within, within the level of comfort or not. So yes, in some circumstances the pandemic has changed terms, but in, in other ways now, you know, we’re, we’re very much in similar territory of, of getting deals done on, on a seller favorable basis.

Ross Butler:

In addition to traditional private equity deals, you’ve got fair bit of experience in the distressed market, corporate distress fields. Are you, are you seeing, or do you anticipate an uptick or an increase in that kind of transaction?

Carl Bradshaw:

Yeah, so for me, those types of deals, whether that’s, you know, out and out distress or a special opportunities, special situation for private capital to be deployed into is different. Another type of private equity deal. It may find its way into a different area of the capital structure, but very much were using similar sort of private equity mindset and deal technology to, to get the deal done. I think the, the latest on the market is that actually there’s not a ton of activity right now. So in 2020 we probably saw cases that had been in a bad state of affairs, you know, financially distressed or underperforming for some period of time prior to the pandemic. And the pandemic was the final straw. Certainly, you know, retail, casual dining has had a very tough time in the last 12 months.

Carl Bradshaw:

And we’ve seen some of that. So we reacted on the restaurant and loan to own restructuring where the lenders to control. And recently we just closed the Clark’s choose transaction where Asian, Asian, private equity invested into, you know, an iconic British brand. So we’ve seen some of it, but I think that all came out of a relatively small window last year. Those sort of existing cases that needed support, I think by and large a lot of businesses have got by to this point through the government support measures, whether that’s, you know, loans or, or just the fact that business rates haven’t been there or at the same levels as, as they were previously. So I think we’re waiting to see, I think the expectation is absolutely there will be a further wave of distressed businesses, whether they make it through this difficult period or not remains to be seen.

Carl Bradshaw:

I think there’s the, there’s a race now between getting the vaccine out, getting consumer confidence to the level, it needs to be, to restore those businesses to somewhere near where they were previously, are people going to all of a sudden June go out and buy things, go out and eat in, in the places where, where they used to and offset against well, w where is the cash coming from to sort of reboot the working capital of these businesses? Right? So they have used the treasure chest to, to get through this period in order to go forward and compete. They’re gonna need likely injections of capital. Now, in some cases that may come from existing shareholders who have deep pockets. In other cases, they may tend to the public markets where currently there is good appetite to put money to work. But in, in many cases, I think they will turn to, you know, private credit, private equity, alternative investing and certainly that’s something where we’re building up for and hoped to, you know, in the, in the nicest possible way be well-prepared to fight, find capsule solutions for these businesses to take them forward.

Ross Butler:

Well, that’s a perfect segue because I did want to ask you about specs, which is obviously all the rage, but really only in the U S to a great degree. But last year was huge and this year is even bigger. Pro-rata do you have any views on the prospects for special acquisition vehicles

Carl Bradshaw:

And get really closely? I mean all the teams in the U S are absolutely inundated with spot instructions on inquiries. And just to, to kind of break that down a little bit, these are essentially the code in the U S these blank check companies. So they’re put together by a management team or a sponsor effectively as a shell company that is then put to the public market investors, pull money into these vehicles, and then the vehicle goes out and finds it at target a cloud product company that then takes to the public market. So it’s almost like a reverse IPO for those private companies. And it’s attractive to investors because they almost get a sort of single purpose, private equity vehicle, right. It’s something they can back if they know the sponsor, they know the management team they can put money towards it.

Carl Bradshaw:

And then, you know, they, they back these management teams and sponsors to go out and find it a great private company. And, and it’s also attractive sometimes. So they’ve project companies looking to raise finance, you know, to fund it it’s next stage of growth because it takes what is otherwise seen as an arduous listing IPO process out of the equation. And they only have to do one negotiation with the spec management team or that all the sponsors. So it does bring that execution advantage, I think for, for public strategy. We haven’t seen all that much of them in the UK. They have existed. I mean, there’s businesses like the engineering giant Melrose, that was a spec from 2003. So they, they are around, but, you know, on a comparable basis. So in the U S there’s something like 223 spots listed this year already.

Carl Bradshaw:

And in the UK, there were for all of last year and, you know, a grand total of 300 million was, was raised through that process it in the UK. So there’s a huge disparity. And I think there is definitely an effort on the part of London stock exchange and other sort of market majors to look at that and assess, you know, are, are we missing out on this opportunity? And I think that they’re coming under pressure because you’ll see homegrown talent that would otherwise, you know, potentially IDEO in the UK or other European markets either look instead of the us and, and potentially even B B not the victim, but the target of these U S rates backs, right? So it’s, it’s a great investment opportunity going into the North American capital markets instead of staying, staying in Europe. And I think there’s two, two particular pressure points that is and, and it all comes down to the nuances between the, the UK capital markets regime and which is similar in some respects and elsewhere in Europe and what they currently have in the U S so one of these is the redemption feature.

Carl Bradshaw:

So in, in the us, you, you, as an investor, put your money into this spot, the spot goes out and finds a target, and then comes back to the shareholders and says, do you want to, do you want to have to make this acquisition or not? So it’s put to a vote at that at that time, you can either vote no vote. Yes. but you can also you know, redeem your investment. So if you lose the value, you’re still not locked in and you can get your money out. And someone else who likes that, that investment can come in in your place. So there’s that advantage that kind of transparency over the, the acquisition and the liquidity that, that you get through that. And then the other the other feature of the UK regime is that because it’s considered as a reverse listing effectively at the time, the SPAC makes the acquisition or announces the acquisition the shares in that spot or suspended for traded and they’re suspended until a perspective on the deal is, is published and there’s no deadlines.

Carl Bradshaw:

So we still have 2017 rates back. That perspective didn’t have it hasn’t been done in that deadlines not being, or that deliverable hasn’t been met. So it, it does create that uncertainty for investors, which I think, you know, looking at it objectively means, you know, w if you had the choice, would you prefer the us model or the current UK model? I think, you know, people are voting with their feet and, and investing into, into the U S backs. I mean, that, that particular feature is there for investor protection. I think when the announcements made that can be a lot of volatility in share price. And so having that, the suspension for a short period of time may make some sense, but it’s certainly something that, that people are looking into is, is a reform needed. There was a review conducted recently by Lord Hill and delivered to the government and at the start of the month, that really looked into all of those things as a, as a sort of holistic EK listing review. And certainly those two features were, were underlined as well as the things that were probably most, most in need of some sort of reform in order to increase spank activity in, in the UK. And the threat is not just coming from the U S but I think now you’ll start to see European markets moving pretty quickly in it. I would say at the current rate, you know, by the end of this year, we could see much more activity in the European markets on that front,

Ross Butler:

Any, any ones in particular.

Carl Bradshaw:

So Amsterdam, I think, has made noises in the last few weeks where they are readying themselves to, to, you know, make, make a viable and attractive destination for the specs, the visual specs to be raised.

Ross Butler:

So if I understand you correctly, it sounds like the, the, the Americans would, their redemption system is created kind of a, a market based optionality for investors. Whereas in the UK, you have more of a regulatory based freeze on everything. And is that a reasonable interpretation? Yeah,

Carl Bradshaw:

But that’s exactly right. I think it’s the, the, just new liquidity, but also the, the, the involvement in that acquisition decision, almost that you get in the U S that you’re not saying encouraged me here in the UK you know, this bank has the options of the acquisition to a vote, but it’s not a regulatory requirement in the same way as it is in the us. Yeah. That is a key distinction.

Ross Butler:

Yeah. It’s, I find it fascinating because, I mean, obviously the number of public companies has been falling for a very long time. And presumably this is going to put that into, into reverse. And it must say something about, I mean, you said at the start where you implied at the start, I think it’s, to some degree, an arbitrage against the cumbersome nature of IPO processes, would you say yes.

Carl Bradshaw:

Yeah. I think there’s definitely a benefit to the, to the company, not having to go through that IPA, do the road shows with multiple investors, you know, in that sort of preparatory stage and just goes straight from a to B you know, suddenly be a public company, having negotiated a deal in a set of terms with you know, with a sponsor. I think that’s, that’s very attractive for companies.

Ross Butler:

Tell us a little bit about Goodwins and your personal aspirations for activity in, in private equity, in a kind of near or medium term, what would you like to see happen and what do you want to get involved in?

Carl Bradshaw:

So Goodwin’s been around in Europe for just under 10 years, but we’re originally a us headquartered firm. We’ve grown internationally into Europe and across into Asia about 1300 lawyers in total, and really we have a very focused strategy. So we’re trying to play in the most dynamic areas of the economy. Private equity is absolutely core to that strategy alongside technology, life science, real estate and financial institutions. And you know, we’ve, we’ve scaled out incredibly quickly in the last year within private equity in London in particular. So we’ve now got upon a bench of about 10 partners, associates another, another 20. And we’re trying to be deep, not just in that transactional capability, but across all areas that touch the private equity ecosystem. So we’ve got one of the largest fund formation things in the market. We’re building out in tact, we’re building out in debt we’re building out in restructuring. So we can really be that go-to sort of destination firm for complex premium private equity work.

Ross Butler:

Carl, it’s been a pleasure talking with you. Thanks very much for your insights this morning.

Ross Butler:

You’ve been listening to the fund shack podcast, make sure you subscribe and visit our website@fun-shack.com for many more video interviews. It’s the private capital channel for alternative investment professionals.

#20 Private equity demystified

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#20 Private equity demystified
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Demystifying private equity on Fund Shack, with Oxford Said’s John Gilligan and the ICAEW Corporate Finance Faculty’s David Petrie

Private Equity Demystified is on the reading list of business schools from Boston to Singapore. It is now in its fourth edition, and in this podcast we speak with John Gilligan of Oxford Said and Visiting Professor at Imperial, who co-authored each editions alongside the late Mike Wright. We are also joined by David Petrie, Head of the Corporate Finance Faculty at the ICAEW, which has been a strong supporter of the initiative and, without whom, ‘the report would never have seen the light of day.’

We discuss the need to demystify, the outperformance debate, the power of M&A done well, and the need to adapt to a very uncertain future.

Ross Butler

David John, welcome to fund shack. I was wondering if we could begin by John giving us a little bit of an overview as to the provenance of private equity demystified, which is now in its fourth edition. And then we can get onto the process of demystification and talking about private equity in this brave new world that we’re in. So I believe that the first edition of private equity demystified in about 2008, which was at the very Dawn of a very different kind of crisis. John, take us through it.

John Gilligan

The backgrounds of this with a conversation over lunch, all good things happen over lunch. I was having lunch with Chris ward, who was the chairman of the Institute’s corporate finance faculty, the ICAEW. And at the time there was an investigation going on at the treasury select committee into the private equity industry. I was on gardening leave between leaving Deloitte and joining BDO. So I was one of the few people who was actually watching this live on tele because I was at home. Everybody else was obviously at work. So I said to Chris, have you seen the treasury select committee investigation? Cause it’s a little bit odd because the questions are very simplistic and the answers, therefore don’t make the industry look very show the answer in the best light. Shouldn’t somebody maybe write a note to somebody to just suggest how it basically works in principles so they could move on to the more interesting substance.

And what Chris said to me was, well, you’re not doing anything. Why don’t you do it? So I then phoned Mike Wright and Mike was my PhD supervisor at the time and said to Mike, well, you’re the leading academic in this field? Could you summarize all the academic stuff? And I had a sort of hidden agenda. I thought I’d get a free literature review for my PhD, but Mike saw through that one. So what happened was we did this and before we knew it, we went back to the ICAEW with Chris and said, well, we seem to have sort of written a bit of a book cause it got longer. And it just coincided with the ICAEW started to think about thought leadership and these sorts of things and such said, well, why don’t we just do it as a thought, a thought leadership piece and then the great, good fortune of life. We published it with a lot of help from people. And I said, it won’t be a huge amount of help from people actually. And then Harvard business school put it on their reading list and you thought, Oh, that’s handy. So that’s, that’s the background to it. And then once we were off the global financial crisis came along. We need to rewrite because the world changed dramatically. And we rewrote about every couple of years David and we’ve done it. So

Ross

A very kind of organic needs led process. David, why did you think that it was a project that was worth really kind of getting behind and supporting

David Petrie

Well, as John said, it, it, it had a very definite need at the time and you know, the, the BVCA does, does excellent work in this area. And it’s not to say, that, you know, they, they don’t constantly advocate the sector, but we, we felt that there was a little bit of a gap perhaps in the perception of politicians and policy makers really. You know, there is, there is this idea that if a particular professional body or a trade association comes to politicians and says, you know, well, you should be doing this because it’s in the national interest, they tend to say, well, w well, in the words of Mandy rice Davis, you know what you would say that wouldn’t you there is always this, this difficulty that they would tend to see them coming and say, well, of course you’ll pay to represent the, you are as it used to say, the voice of private equity and venture capital whereas the Institute of chartered accountants does as part of its Royal charter include the provision to act not only in the interests of the profession, but also in the wider public interest.

And so the analysis that John and Mike did, has kept things up to date really with what’s been going on private equity industry. Certainly, certainly hasn’t stood still, but as John has also said, it has become a really very comprehensive text. And it’s useful for members of the corporate finance faculty and more broadly people hoping to enter the private equity sector as well as principals and investors in it. I think these days, because it is such a comprehensive piece of work you know, I think they probably started off attempting to write a relatively short book and found that actually what it is an extremely complicated and nuanced sector actually, and to understand it properly, it isn’t possible simply to set it out briefly though our levels of complexity that I think that even people working in the sector may not fully appreciate. And the fact that it is it’s sites over 200 academic references means that when we’re having discussions with policy makers in white hall and Westminster about the importance of private equity and its contribution to the economy and so on, you know, the evidence is irrefutable.

It is grounded in very solid research is, is not simply the view of a trade body. This is really solid stuff, but it also works very well for practitioners, for our, you know, younger chartered accountants who are wanting to make their fortune and private equity. This is a really good place to start in terms of how, what are the nuts and bolts of the business. So this is why business schools above it. And I’m sure John would be able to talk about this a lot more because it really genuinely is on the reading list of business schools from Harvard to Hong Kong. So it works at all sorts of different levels. It, but it busts myths on the sector and explains that it does add to economic value. And it also is candid about some of the criticisms leveled against it, but it also provides a very useful how to guide and that’s what we like. So you know, we, we are delighted to support it and to continue to do so, because it works for us at so many different levels.

Ross

I think that’s a really great summary. That is really the impression that I got reading it as well. David, just to look at the political side, I mean, it’s not an apolitical book, but it is incredibly balanced. And I think there’s a lot of academic work out there. Even that’s highly critical of private equity. And I think where, where things are known and the facts are put forward and when then where they’re not known, I actually think you’ve got a section John saying, you know, look, look at the evidence base. And often it’s not there for private equity.

John Gilligan

Well, one of the things we set out to do was not to be an advocate for any particular point of view, but to allow people to get to the point where they can ask the question and decide for themselves. So the whole idea of gathering together, the evidence was we only use evidence that is rigorously academic. So we don’t, for example, use pretty much any evidence produced by people who have an ax to grind one way or the other. So we wouldn’t use evidence from a trade body without commenting on it. So it’s all of the, all of the reference cited a peer reviewed. So the first point is we’ve done the exercise to get the data in one place. If you look in the appendix in appendix six, I think it is, it’s all there. It’s summarized in one paragraph. So you’d have to read the paper either, but there are paper references there.

If you want to read the paper. So if you want to dive into there, you can go there if you want. And the idea is to say, well, this is what we know, but here’s, here’s what we don’t know. And here’s the stuff that, where people have strong opinions where their opinions are based upon evidence. That’s. I mean, the evidence has been growing, but evidence is incomplete because one of the problems, I mean, it says it on the 10th, private, you know, it, I don’t think private is private because deliberately secretive. I never, I’ve never believed that. I think the private equity didn’t really care about communicating outside of its closed circle for a long time, because they never really thought about it. When we started, we made the point that private just means not quoted. It doesn’t mean secrets. It’s become, there’s become a public interest in it because it’s not so big and that’s legitimate. But back in the day, people say it’s secretive. It wasn’t secretive. They just hadn’t really thought about communicating with the people who didn’t to that point, how an interest. So we have, we’ve been through this process of unpeeling, the onion, where data has become available. People would come or interested. And a lot of the early academic research turned out to be wrong because the data was wrong. So a lot of it’s been rewritten. Some of it good, some of it bad.

Ross Butler

Yeah. I certainly didn’t get the feel that I’d be, I was being preached to, and to David’s point that it can appeal to many different constituencies. It really does feel like a manual. I feel like if you gave me a hundred million, I can at least go through the motions of managing a private equity fund. And every time I get stuck, I could just pick it up. Now there’s a, there’s a, there’s a lot of skill that goes into it, but you certainly kind of hit all the points in terms of, you know, from start to finish.

John Gilligan

The thing that we learned as we were writing, it was we started by, we were the first people to sort of sit down and try and write something that wasn’t either aimed at the management of the company during the buy-out or the investor in a fund. But we’re trying to just say, look, here’s the big picture. And here’s how it works. So it was more curiosity than, than anything else. And what became clear as we did each edition was this is an industry that is very intricate. It’s not complicated, but it’s very, very intricate.

And if you don’t understand the intricacies, you can’t draw the right conclusions. So the classic one is taxation of current interest. Taxation carried interests top of the agenda at the moment. Most people don’t understand a really important point about the taxation carried interest. The definition of carried interest in, the tax legislation is that amount of capital that is taxed as carry that amount of, of return. That’s taxed as capital in an LP agreement, carried interest is 20% of the return. They’re two different things because the return has interest fees and capital. So in the tax legislation, it’s defined as capital in the LP agreement. It’s 20% of all the profit. If you do the arithmetic and look at how much return comes from interest fees and capital, you’ll find it’s Ferris and fund to fund, obviously, but a lot of return comes from interest and fees.

That’s taxes, income. So a large proportion of carried interest is taxed as income already, but unless you know, that the definition and the tax legislation is different to the definition in the LP agreement, you’d never know that. And you have no idea how much time I spend talking to journalists explaining that the thing that’s certain in the tax legislation is different to the thing that’s written in the LP agreement. And it makes a difference what the tax rate is and has any journalists picked up on it and written it in front of genders. They’re interested in, and now we’ve, you know, there was an article in the Ft recently, and that point has now been been made, but it’s not try explaining that in a headline. And it’s not very exciting either, but it’s important.

David Petrie

Yeah, we certainly find it very useful when we’re talking to officials in the treasury and so on about fiscal policy and how that relates to government investment programs and the development of new funds and so on, which is what we’ve been quite busy attempting to assist within the faculty over the, certainly over the past nine to 12 months as the government has looked at other measures, which might increase the flow of funding into those bits of the, that are short of cash. And you know, there are all sorts of you know, in a crisis, all ideas are considered however, however, left field. And so sometimes it’s been quite helpful to us to be able to explain to people just how some of these things work, but in a context of an open meeting, you can’t necessarily do that. It’s actually quite handy to say, I’ll tell you what, I’ve got, something that I suggest you have a look at that just, you know, you can’t really say to people, you need to start with the basics, but if you are looking to do that, this is, this really is a very, very good place.

So I do use that to help people gather a sort of a background understanding of how some of these things really do work. And and, and it really is. It really is very effective from, from that perspective. And also, I think one of the other things that is particularly important about this latest edition is that John covers in some detail, not just some of the changes over the past two or three years in terms of the way that private equity funds have been well doing just that raising funds and structuring themselves and what this means for the broader economy in terms of systemic risk. So there are some important factors there that the government officials and the bank of England have been looking at, and we’ve had helped them use this addition to explain, but also more broader questions about, you know, how should public money be allocated to support businesses that might be struggling at the moment.

And again, that is touched on in the addendum to the text, which John wrote with Jim Strang after the original copy had gone to press. So there are a few, well, not a few, there were a lot of very important policy implications throughout the document, I think all throughout the publication, but we’ve certainly found it been very useful to support our work in determining policy, which then in turn leads to government intervention. So it’s it’s a useful underpin to actual fiscal policy when it’s working at its best. And I can say that there have been times when we have used it to to aid understanding and and it, and it’s proven very effective.

Ross Butler

I thought that the book was worth getting just for the penname that you wrote John with with Jim Strang, which is just a couple of pages, but I thought it was really interesting looking at how things are, you know, cause everything’s changed now. Right. But my impression from those pages was actually that I’d be relatively sanguine from the perspective of a private equity fund investor, but that perhaps some other constituents might feel some heat.

John Gilligan

Yeah. Jim Strang and I read that in April and it was the first thing that was first time we’ve ever tried to write anything with people when we couldn’t sit in a room together. So it was first time we did anything over zoom, which was the first word thing, but the private equity she’s been through a number of cycles. I mean, depending on how old you, I started in 1988, I lost track of how many crises I’ve done. This is obviously a longer and different one, but the industry has come through. Many of them and each time has gone in, there’s been this fear that the leveraging things will cause a problem. That’s essentially at the heart of what they, what the issue is. People concern that overleveraging things will amplify results that are bad and that will be bad. And we’ve argued for 13 years or whatever you were writing that because the funds haven’t been leveraged.

Now, there’s, there’s been changed in the fund structure, which means that’s creeping in. And we kind of said in 2007 that’ll happen. And it is a, but we don’t think at the moment is any evidence that that’s going to cause any kind of systemic risk. But the thing that is different is the structure of the banking market, which is radically different. And that’s, that’s the overflow from the last crisis. You know, the GFC changed the rules of banking to make the economics of leveraged finance different. There’s more catio on capital in banks now than they used to be against leveraged debt. And that allowed the debt funds to come into the market. So many of the debt funds in Europe essentially were the mezzanine funds. You started moving down the capital structure and then the us model came over here.

Those funds are leveraged and indeed some of those funds leverage each other and there’s as yet, that’s not yet been through the mill in Europe, it’s been through the men in the States. The concern is that some of the smaller funds, because these funds are actually relatively shorter, so privately funds 10 years. So if you’re going to have a crisis, every, every decade, you’ve got to probably hit war on average debt funds are shorter. So if you raised one in your first fund and you went into the crisis, you will have no ability to have no track record, to raise money for the next ones. So we have a, quite a fragile environment for some of the new entrance into that market over the last decade. And when we come out of that, of this crisis, which we will in the world will be better.

John Gilligan

It will be, it’ll be interesting who survives and who doesn’t, if you pitched yourself as a retail uni charge provider or a travel sector specialist, you know, the world got bad and there’s nothing you could done about it. It’s just, it’s just a caustic event. Conversely, if you’re a turnaround investor, maybe the world got more interesting. But the one thing we do know from each crisis, this is always been a good time for the equity investor writing checks. When the world has been bad, has been a good strategy over the years for the, for the GP. Interestingly for the LP, the evidence is that you can’t pick the time to invest because you don’t make the investment decision that the GP does. So when you can make an LP decision today, or your GP might not invest the money into three years, so you won’t miss this, this with this window,

Ross Butler

Which some could say is central to its inherent advantage because you can’t just flip flop and change your mind. You’re, you’re stuck in it through good and bad.

John Gilligan

That’s the reason it doesn’t spread risk is because you, you, you made your bet and you bet on it. Now the secondary markets and the ability to do leverage positions, changes out of bet and it’s eating away at the edges of it. The analogy that runs through my head is a bit like you know, when people used to snip the edge of coins in the 17th century, there comes a point when you’ve debased the coin. We’re not there yet, but that’s, that’s, that’s a sort of a similar analogy. We’re just chipping away at the model a bit, bit by bit. And the original model of you. And I set up something for 10 years at the end of 10 years, if I’ve made some money, you pay me 20% of it. And if we haven’t, you don’t, that models are now evolving very rapidly.

Yeah. And, and so the jury is out on the performance of debt bonds, but do either of you have a gut feeling with regards to the impact of debt funds on mainstream private equity. If we were to hit a situation where there was a lot of workouts and insolvencies and so on,

I mean, that’s organizationally, that’s the interesting thing about the smaller funds is they don’t have the internal organization to do that because they weren’t jumping around long enough and working things out is, is a labor intensive exercise. So then one of my, one of my colleagues I’ve been on the investment committee, a big issue, investor impact investor. One of my colleagues is of work is a partner of a workout fund. And what they do is they buy other people’s problems and solve them so that, you know, there are routes to, to solve these problems. But the original investor went to the benefit of that when you invest in. So there is a question as to are there enough people to know how to do this and all the in the right place, because they’re originally in the banks, the banks had workout departments. Now, maybe those people are all the people that are sitting in the, the debt funds now, because many of them would have left. But, you know, that’s the question

David Petrie

I think the other couple of other interesting things to say about that question, Ross as well. I mean, the first thing is that we’ve not really seen the level of insolvencies that we were anticipating, or indeed that many of us anticipated at the beginning of this back in back this time, last year, really all last March when we went into the first lockdown you know, the statistics are very, very clear. You know, the number of insolvencies is Cigna is, is less in Q4 of of last year than it was in 2019. So that’s, that’s the, that’s the first situation. I think many of these businesses are not that many of the difficulties for debt funds haven’t yet hit. As John has mentioned, you know, those private equity houses that have found themselves with businesses where they’re working, capital’s got stretched to such a level that there that businesses is unsustainable.

I suppose there’s no other sources of capital. Then they’ve, they’ve taken some fairly urgent action or some too desperate action in some cases. So there have been some high profile, private equity backed failures in the sort of within the sort of six months kind of horizon of the crisis biting. But they could, well, if some of those could well have been businesses that were already struggling for a variety of different reasons, I think what is also interesting is what you’ve seen or what we’ve seen more broadly with the actions that private equity took you know, over the past nine to 12 months. So the first thing that they did was look very carefully at their existing portfolio. Some businesses were doing well and others were clearly under a great deal of strain. So the things that private equities consistently argued that it does well is bring professional management into businesses.

So in, you know, ask providing an external perspective and looking at ways in which the business could be adjusted, working capital management could be improved yet further diff unfortunately difficult decisions could be taken in terms of reducing operating capacity and sadly reducing head counts. And so on the private equity funds took those. They, they move very quickly with their existing portfolio businesses, but then they also found that they had a lot of investee companies that were pretty much business as usual and alongside that they also changed their investment philosophy and private equity for, for many years is recognize that it can change the significantly changed the value of investee companies by building together similar companies as so-called buy and build approach. They recognized that this was a very, this was a, this was still a way you could do deals during lockdown. So John said they could, you know, you can, de-risk an investment because chances are what you already know the sector by definition with buy and bill, because you’ve got an investee company in it they’re already, so you’ve done your due diligence on the market and the dynamics of that, your content about that.

And there’s a very good chance that the management team probably also know personally, you know, the other people within the target company, they met, they certainly know the customer base, the dynamics of it and so on. So that the private equity houses are able to use their existing resources, existing management teams, and so on to help them do due diligence, due diligence, investment targets. So we saw that developing as a way for getting transactions done.

John Gilligan

The great truth of private equity is cost of capital drives a lot of things. If that’s cheap, then, then transaction sizes rise and the are recalled giving a lecture 18 months or so ago with a colleague from Goldman Sachs he said, look, it’s a bit like being in, in the final of the French open, which still has you still have to win by two clear games in the French open, so you can keep playing till the end. So it could be 17 all, you know, the ends on the way, but you have no idea whether it’s going to be 1917 or 39 37, but it felt like that before we came into the crisis, because we were at the top of the market. And so when we submitted the book to the publishers, we actually said, again, we submit this nine we’re at the top of the market.

We had no idea virus was going to be the thing that disrupted it. I was completely surprised it was all obviously, but it’s still the case that we have this strange atmosphere across the capital markets where the cost of capital is distorted by quantitative easing and low interest rates means that the asset value inflates and when that’s unwound, the asset values will fall. We just don’t know if that’s going to unwind quickly or slowly or how that’s going to happen because nobody’s ever done it before. And the change of government in the state Springs to Janet Yellen back to the table. And she was in the process of slowly unwinding that towards the end of the Obama era has moved. Music has changed because the world’s changed. But that’s the kind of the, the big unspoken elephant in the room is what happens if interest rates rise significantly, because that goes back to the evidence-based, doesn’t it? Because the majority of the growth in this industry, I mean, it was a cottage industry before quantitative easing almost, and now it’s huge for many years.

So yeah, nobody knows. And I guess the, the other thing going back to David’s point is, yeah, there have been some sectors that have done phenomenally well, you know, software being the quintessential beneficiary of lockdowns. And then there are the sectors that I think David was alluding to where they’ve they’ve had problems, but those that are backed by investors with deep pockets, see it as a time to go hunting. And they may well emerge even stronger because they will dominate their sector, I guess, having rolled it all up. I mean, there, there is that. I mean, there’s the buy and bill thing is an interesting change. One of the questions that perplexed me since I started doing this all those years ago is all the academic evidence. We have suggests the M&A generally destroys value and all the academic stuff we’ve got about private equities, generally private equity at a gross level, outperforms markets, private is an M&A driven business.

That’s what we did. So how come the business that is focused on M&A and pretty much something else is outperforming the market when all M&A token taken around generally suggests that it’s quite distorted. And this is the kind of question that we wrestled with for years and years and years. It’s what we call the paradox of private equity is people do M&A and they make larger gains that larger returns than if they didn’t.

Ross Butler

David, that a controversial statement, I guess, from your perspective as a chief executive, the corporate finance faculty.

David Petrie

We tend to take a slightly different view in a rather more optimistic view to the value added by M&A than than, than perhaps Johnson indicated in the academic evidence. We always used to be entertained by a report that used to be published by one of the major accounting firms suggesting that M&A destroyed value. And we thought, why the hell are these guys publishing this? But of course, what they were publishing this fall was because they, the, they are, their argument ran of course, well, smart M and a with good due diligence and so on and all of these things. But of course, nobody goes into a transaction expecting it’s a fail. You know, so what, what has happened that has may have resulted in reduction in value, and the answer is things haven’t worked out the way you thought they would.

Yeah. So why is that? And these, these can be systemic issues. They can be political, you know, it’s all the usual, the usual analysis that John and his colleagues teach their students in business school. One of the areas in their pastoral analysis has changed beyond their imagination, original imagination. If there’s something fundamentally wrong with the target, then even some of the largest examples illustrate that it is possible typically to take legal action against the the sellers. Americans are making a very unfair to Americans by the way, for any Americans watching, but in the unit in the U S I should say, I should preface my remarks by saying that the use of warranty and indemnity insurance is become much more widespread than it ever was 10 or 15 years ago. And also the propensity to claim against those policies, which is where my well, I’ve dragged my Americans into it.

You know, the, there is evidence that suggests that American acquirers are more inclined to claim against WNI policies than perhaps it’s typically the case in Europe. And that, again, I think is a function of the way that those transactions are done again on the basis of completion accounts rather than the lock box mechanism, which is you know custom and practice in the UK, but it’s not to say that these things, you know, won’t won’t change. And but I think, I think there are lots of probably lots of factors actually, which might contribute to things, not working in quite the way that people expect, but it’s not something that we tend to like to talk about. And a few years ago Vince cable had had a good look at this and commissioned a piece of piece of research.

Looking at the value that M&A did actually add to the markets and that particular research illustrated that the impact was, was relatively neutral. But in the corporate finance faculty, we give an award every year to the public company that has added most to shareholder value through the use of M&A activity. And this year we did an analysis to look at past winners of these awards, because of course, as many people know, a lot of companies fear the curse of the award. As soon as you get given an award values collapsed, and something goes horribly wrong. This is not the case, actually, in, in eight out of 10 of the businesses that we gave an award to. And given that they were all public companies, if you’d invested in the stock of each of those businesses, you’d have, you’d have generated a return. That was significantly ahead of any average industry and most tracker funds, because these businesses were making very judicious use of M&A and very effective use of M&A to add to shareholder value.

John Gilligan

Yeah. what, what, what may am I kind of pick to weigh out over the decade was trying to answer this question, how come this thing is happening? And we think on the conclusion of the book in a sentence is we think it’s about process. We think it’s the fact that private equity firms are good at doing this stuff because they do it in a fixed process. So there are other, like, there’s this idea that great deals get done over a napkin, sitting in a bar over a bottle of wine between two entrepreneurs. Those are the ones that probably go wrong, because if you do a process and you have a process that you do every time, what you do is you select out the failures quite, quite efficiently. You know, there, there are waves that can swamp you like this tsunami of, of, of the virus.

But if you select it are all the things that you could have selected out reasonably, then you avoid the losses when you avoid the losses, that makes a big difference to where you’re going. And we think, but we haven’t yet been able to demonstrate, cause we haven’t figured out. We never quite figured out how to do it. In fact, I’m doing some work at the moment that I called Tim Galpin, Oxford on this is what is defining the success of private equity is two things. One is the, on the way in, there’s a process that not only buys as well, but implements the purchase process. Post-Completion well, so the a hundred day plan thing. So due diligence turns into action. And secondly, the focus on exit makes people do it quickly, because if there’s one thing to say, I’m going to change the strategy of this business over the next decade.

And there’s another saying, I’m going to have to do it in the next three years, three to five years, and you can just work quicker. And we think those two things are at the heart of, or probably our conjecture is that those are at the heart of why this works. That sounds plausible to me, but could you not kind of zoom out a little bit further and say, well, the processes, the function of the structure of the LP structure, it’s not just the LP strip to think about the different surfaces. Imagine I sort of business GE some years ago, and they’re really good acquirers. They have an internal process, but it’s all internal. So it’s an internal process. And their level of knowledge in that process is limited by the number of transactions they do, which is a lot or used to be a lot when they were very inquisitive.

Now imagine that your, I don’t know, pick a fund, doesn’t matter. Most of those funds externalize the process. Private equity is a big user of the services provided by people like Amelia and other people know we did a lot more transactions than anybody else did. So we learned more. So the, you know, the big four accounting firms and GT and BDO below them do more transactions per year than any private equity fund in the world by orders of magnitude. So funnily enough, the people who have come across the problems tend to be in those footsteps. Some of them ended up moving into private equity. So one of the conjectures is that by externalizing a large proportion of that process to people that you work with consistently, you’ll get the benefits of their learnings. And therefore you avoid mistakes. You would have made had you not used external advisors, corporates use of external advice less, and therefore they’re more likely to fall for their own beliefs as it were. They don’t have an external check mechanism in the same way. So when we were conjecturing that, you know, you hear a lot about passion and vision, all these sorts of things in business schools, and my colleagues do all this, but maybe here competence is what we’re talking about. You know, being very competent, a process might make a hell of a big difference.

David Petrie

Yeah, yeah. I was just going to say that that certainly the view expressed of course by very many of the members of the corporate finance faculty who are themselves advisors and they do, as John says, they do, they do see the same things day in, day out. And you know, again even some of the larger or mid market houses, I guess in the UK might do 10, 15, 20 deals a year, but they’re certainly not seeing exactly the same thing in quite the same way. And the increasing specialism within the advisory firms as well, again, increases that level of expertise and that ability to be able to say you know, this, what this, this could be, this could prove to be one of those unforeseen difficulties that I was talking about a little time ago. They’re not really unforeseen they’re they’re things they’re factors in investment risk that people just might look at differently and be proud.

And to actually take a, perhaps an artificially optimistic view about at the time, because it happens to fit with company strategy. And I think that to, to sit alongside John’s analysis or perhaps to, to, to add to it or to add facto, no doubt they’re considering is that I think in private equity, they’re set up to monitor changes and KPIs within a business extremely closely and where things are going wrong. They will tend to know potentially anyway, not this is generalizing, but perhaps quicker than they might within a private company or public company, perhaps they will know sooner that something’s going wrong. And, and also perhaps they will be more inclined to take action sooner. You know, one of the facts and perhaps John I I’m worried that I don’t now have academic evidence to support this, but there is a lot of anecdotal evidence amongst the advisory community to suggest that private equity managers change management teams

There’s, there’s evidence of that. There’s, there is evidence that private actually changes management board, anybody else? Absolutely here.

John Gilligan

Yeah. And they’re doing that in order to, they are proactive managers, they will step in and intervene. And there’s not necessarily perhaps the giving an investment, the benefit of the doubt, if we could call it that, that you might get in you know, a, a public company transaction where it might be, well, we don’t quite know why this isn’t working, how much of what we’ve bought is, is now integrated within the much larger organization. And therefore it’s less easy to assess exactly how much value that it’s actually added to the, to the, to the whole. Whereas if you’ve got the thing running discreetly, it’s much easier to to assess its performance. So there’s a whole series of different factors that are at work here and academic support and analysis of these things does allow for directors to challenge some of these, these concepts, these ideas that, you know, we know that we need to be careful with M and a, because, you know, we’re concerned it doesn’t necessarily add value. And how can we change our processes, try and minimize risk, taking it back to private equity demystified. That’s where, you know, some of the principles in private equity may not think about some of this stuff quite that way all the time, but having, going back to the text and say, yeah, actually that’s an interesting trend. We need to have a bit of a think about that. It’s really great

Ross Butler

And he’s coming on again soon to talk about his new book on, on governance, which, sorry,

John Gilligan

I was reading Simon Witney’s new book on Governance last night, a friend, and there’s a point that he makes in that book, which is far more scholarly than I am, and often a lot, lot smarter than I am. But the point he makes is, is that if you stand back from this and look at the simple decisions you make as a shareholder shareholders in public companies have the option to sell. So the private equity shareholder has to have the option to fire because they don’t have the option to sell. And so the reason you change the management is because you don’t have the option to bail out. And that’s, that’s the sort of the contract you enter into. You have this simple idea of if I don’t like you I’ll sell and that we know that will be affected, the market will make the price of the asset fall because of that, you can’t do that in the private equity world, or couldn’t historically get this bit of secondary trading. You can do it on now. So you have to have the option to fire because what else can you do now? There isn’t a third option. And that’s, that’s again, one of these things that David was saying, I mean, it changes the game. If you can’t sell, you got to do something else.

Ross Butler

Yeah. There’s an interesting interplay between the advantages of the governance model and the advantages of the process that you outlined as well. And obviously they’re interlinked, but they are separate as well. Yeah.

John Gilligan.

Yeah. I mean the governance thing sort of comes from the process. And so there’s a process on the way in which is a bit I know. Well, cause you know, I was an M and a person and then there’s a process once you’re in, which is, which is kind of embedded in the, in the governance piece. And the thing that strikes you when you deal with a private equity fund year on year on year, is how consistent that process is a cost of pay.

Ross Butler

I’d really like to try and bring you two together on the point because I think it can be done listening to you both. And so let me try you on something, which is that the academics may have discovered that MNA may on average destroy value, but the average does not necessarily dictate the overall benefits of an activity. And David’s prize is highlighting people that have hits upon a successful formula and are accruing knowledge along the way. And your description of private equity does the same thing. And so while the average may destroy value the activity as a whole may be a creative

John Gilligan

That’s absolutely. Right. Right. So the, the whole, one of the biggest problems that the conversation about private equity has generally is the average is a coastal over the place. So the average return on compared to the average return on a market, is that a meaningful thing? And the answer is, well, not really, it’s not meaningful for a number of reasons. One, nobody buys the average. When you put leverage into things, you make the dispersion of the distribution bigger because you amplify everything. So th th this constant question of does private equity outperform the market. I sort of got to the point where I don’t think the question makes any sense anymore because there’s now leveraging funds. So I, as an investor in the fund, first of all, investors don’t get the same deal. If I put a hundred million pounds to a fund, I get a different deal.

And if I put 1 million pounds at the same site, secondly, there’s leveraging funds that comes in and out. So depending upon when I’m in that fund, if I’m trading in the secondary market, my returns would be different to yours if you stayed in across the whole piece. So even within one fund, the LPs are getting different returns. So what does the average mean? No idea. And then there’s this, this, this whole question of what does it, what’s the average of what if you’re doing turnaround investments in France and I’m doing buy and builds in Spain? Are we doing anything similar? I don’t know my organization, it looked very similar when we draw an organization chart. I mean, might all be in my book and, you know, we might put them down as a private equity fund, but is it really sensible to compare us?

Because the strategy is really the question. The real question is an investor is what do you say you’re going to do? Did you do it and give him the risks I took? Did I get a return for it? And comparing, I know every always picks on KKR. So I was picking know some large buyout fund CBC, God fed. Doesn’t worry about it too. LDC or inflection, or I don’t know somebody else, is that a sensible thing to do know? It’s a bit like comparing the performance of somebody in Chelsea football club to somebody in Harlequins rugby club. They’re both playing a sport with a ball on a field, but they’re not trying to do the same thing.

Ross Butler

Have you come across the American intelligence definition, the difference between a puzzle and a mystery, which helped probably mangle, but puzzles. Basically they have an answer, at least in theory, they can be sold computationally and mysteries don’t have a single answer. And even when you have all knowledge, it’s still unclear what it is. And so it strikes me that private equity demystified as a title is peculiarly appropriate. And obviously it’s very much needed as well. So it’s been a great pleasure speaking with you both. And I really commend the book. It’s it, it’s actually a good read as well. Thank you.

John Gilligan

And also, so that everybody buys it, I don’t make any money out of it. We give all the money to the big issue where I’m a trustee of the charity. So if people want to give money to charity and also learn about, about private equity, as I said in the post on LinkedIn, it’s not bandaid, but it does a bit.

#18 Vania Schlogel, Atwater Capital

Fund Shack
Fund Shack
#18 Vania Schlogel, Atwater Capital
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Vania Schlogel is managing partner and founder of Atwater Capital, an LA-based international private equity firm. You can watch the video version of this conversation here.

Vania Schlogel is managing partner and founder of Los Angeles-based Atwater Capital, a private equity firm with an exclusive focus on media and entertainment. Vania cut her teeth at Goldman Sachs and KKR. She was on the board of Pets at Home, and she was CIO of Roc Nation, Jay-Z’s entertainment agency. And she currently sits on the boards of private equity back to media and entertainment businesses across the US, Asia and Europe.

ROSS BUTLER:

Vania, welcome to Fund Shack. You are quite an unusual private equity investor in as much as the creative industries don’t scare you. In fact, that’s what you focus on, specialize in. How did you get interested and involved in it?

VANIA SCHLOGEL:

I saw so much value from marrying those two worlds. So the very kind of disciplined and rigorous private equity side of things with the innovation from the creative world. And I just always had the natural interest in it. The creative side of things, obviously as, as, as an individual who consumes content and music myself, and as an investor really experienced that marrying those two worlds could actually help an investment in terms of equity, value creation, generating returns on behalf of our LPs. And then I know this not many folks were doing it, so it seemed like a natural opportunity to get in.

ROSS BUTLER:

So what, what, when was your kind of Eureka moment that actually there’s an investment opportunity in this industry?

VANIA SCHLOGEL:

When I was at KKR one of the investments that I was involved in was the buy and build strategy that built what is BMG today. One of the world’s largest independent music publishers, and it was really my first foray and ability to actually invest in the creative industry. And I think one of the things that was very successful about that investment is we, as investors were able to go in and provide a body of knowledge and expertise as to what we were good at and focus on that. And I think what we did really well is let the creative guys focus on what they’re good at. And so we were backing a great management team and company with capital and M and a and integration expertise. But then we also knew when to not overstep our bounds. I can’t recall who said it, but there’s, there’s this joke in the music industry about the CEO that wants to see himself in the music videos? I think the most successful thing we did is we made sure that we were not the CEO that wanted to be in the music videos or the shareholders or board members, however, you’ll term it. And, and that was my Eureka moment where I said, this is a great investment. It’s a lot of fun. I tangibly understand it. I get along really well with these creative executives. And from there on, it just became as you know, what happens in life, you one thing, and then suddenly more opportunities keep coming in that vein.

ROSS BUTLER:

So you, you had it with a traditional private equity house, but why do you think the traditional private equity market doesn’t see it as necessarily a big sector ?

VANIA SCHLOGEL:

Well, I,do think they see it as a big sector. I think that there is more appropriately put there’s a lot of opportunity from actually investing in the sector, but then taking the next step of being really operationally involved and plugged in with the creative sector. And I think the primary reason, honestly, why it is not a big operational focus for large private equity shops is because they’re very, very good at what they do on an operational level. So implementing an ERP rollout or optimizing a supply chain, these are scaled replicable, operational strategies and processes that they can apply to their portfolio companies, really building a deep partnerships. And the operating level with creatives is time-consuming and not always replicable to other portfolio companies. And so it’s more of, I think, a scaling issue and we’re kind of happy being the smaller fund that goes ahead and steps into that role as a partner to a lot of larger GPS.

VANIA SCHLOGEL:

Yeah. It’s a chemistry thing, presumably that, you know, people that set up creative business are probably quite different to almost any other kind of business, I guess, and you have a good kind of chemistry with them. It sounds like.

VANIA SCHLOGEL:

Yeah. And I think at the core, in any case investing is a human centric business, but when you do delve into the creative aspect and, and partner with creative executives who are very much more around, you know, emotion and being led by intuition, it is very important to jive on a personal level and to really take the time and build those relationships. And I will say that despite the fact that we have wonderful working relationships with a lot of creative executives, myself and a lot of Atwater’s executives are also personal friends with our creative partners. I think that works really well for the industry.

ROSS BUTLER:

It’s quite a rare individual to be both creative and to be able to be more financially focused as well. Do you come across many creative entrepreneurs that can and do do both?

VANIA SCHLOGEL:

It is, I would say it’s more of a rarity. I definitely have noticed that a lot of a subset of folks that do this really well seem to be founders and entrepreneurs. So we back, for example, certain portfolio companies Oscar Hoagland, who’s the co-founder and CEO of epidemic sound. He does really well in terms of liaising with both communities. And so it’s not a common skill-set. We do see it, but I would say I see it most often among CEOs and founders, and maybe it’s because I don’t know us founders, we have a, a little bit of that craziness, the risk taking the innovative, whatever you want to call it, but just enough there that we’re willing to kind of get out of maybe the modality of thinking in a, in a typical private equity or consulting or whatever.

ROSS BUTLER:

So you will come your private equity firm Atwater it makes it a virtue of being operationally involved in these creative businesses. To what extent do the businesses that you invest in kind of welcome operational input and to what extent do they need it typically? Yeah.

VANIA SCHLOGEL:

Well, let me answer the second question first, because I think that’s the easiest every business, every individual, any organization of people can improve in one way or another. That doesn’t mean that our ideas are always right. And in fact, that’s one of the first things that we strive for in our relationships with management teams is feel free to kick us in the teeth and tell us if these ideas are completely asinine. And we genuinely mean that. And but is the, is the opportunity for improvement there? Absolutely. And the best founders and management teams recognize that then going to your first question about how welcome is that we as a fund, so we’ve invested about a hundred million dollars since I founded the fund in 2017. And in all our investments today, we’ve been a minority shareholder de facto.

VANIA SCHLOGEL:

That means that even if I wanted to, from a governance perspective, I cannot come down with edX from above and say, this is what you must do. And in any case, I genuinely think that’s kind of bad, bad governance and a poor way of managing these relationships because a lot of the CEOs and founders that we work with have been in the business for years, sometimes from inception. And so it’s incumbent upon us to actually come up with ideas an operating level to, to present a Rolodex within the industry that is exciting for management because we’re very open about the fact that yes, despite the fact that we may be represented on the board and can vote shares a certain way. My personal experience has been in less management really wants to work with you. Your operational strategy is not going to be that effective. And so it is a foundational thing for us to come in as investors and really form number one, deep personal relationships. And number two, actually show up with the goods because we’ll get called out right away by these very demanding founders and CEOs. If we’re not showing up with something that’s helpful for their business,

ROSS BUTLER:

And what’s the competitive environment like for attractive assets in this sector,

VANIA SCHLOGEL:

I would say our sector is more, is more right for proprietary deal sourcing than potentially other sectors. And it goes back to what we just talked about, which is that kind of creative and founder led group of folks. There’s so much that is based upon relationships and how well networked are you in the sector? How well-liked are you do founders talk about you in a positive fashion. And it’s interesting, both what I’ve witnessed is both on a positive and negative level founders. It will, it will spread like wildfire among founders, if you are seen as either a great partner or not a very good partner to management. So I actually think within the sector being, being well-networked and well-liked lends itself to proprietary deal sourcing, which means it’s outside of a normal process being run for example, by an advisor. And in that kind of case, that’s actually the ideal scenario because it’s not a competitive process. Aside from your main competition being against yourself, are you presenting a compelling case to the founder and CEO and the existing shareholders that you’re worth it, that they should sell some of their shares to you because you’re going to, going to bring value.

ROSS BUTLER:

Yeah, I can imagine that the LA creative great vine is quite sophisticated and active, so the word would get round, but you’re not just you’re based in LA, but you have an Asian presence and you recently did a European deal as well. Talk to us a little bit about your kind of geographic coverage.

VANIA SCHLOGEL:

It’s really funny because prior to parasite winning an Oscar, which is a South Korean movie, we would always get the strangest looks when I would explain that we have offices in Los Angeles and Seoul, South Korea, because most funds are based in New York and London and San Francisco. And then when they go to Asia, they immediately typically go to Hong Kong or Singapore, you know, kind of a financial hub. And the way that we explained it is we’re operational investors. And hence we launched in Asia in a very operationally relevant geography. So South Korea has the fastest internet speeds in the world. It’s a thriving and healthy democracy. It’s intellectual property protection laws are very robust. All that put together means that the monetization methods and kind of the business ethos, also legal protections endemic to South Korea, feel very natural for Western portfolio companies to launch into a, so you have to get over.

VANIA SCHLOGEL:

Obviously some of this is natural, no matter where you expand to globally, but, but you know, you need to be comfortable with the language barriers the cultural differences and being respectful and mindful of that. But once our portfolio companies launched there it feels much more like a fish in water in terms of them looking around and saying, Oh, okay, I can still sell my intellectual property for example, and monetize it the way that I would, whether I were based in Sweden or New York or, Seoul. So that’s one of the reasons that we set up a presence there. And going back to the example, also a parasite winning an Oscar, we identified very early on that for whatever reason, Koreans are very good storytellers. And so there’s always been a large body of a great intellectual property and content trends coming out of South Korea.

VANIA SCHLOGEL:

And so as the fund focused a lot on entertainment, media, and content, it made a lot of sense to us to be present in cities that were driving these trends. And it’s one of those markets where a company can launch. And admittedly, it’s a very small country and a very small core addressable market, but given the ability to export cross border a company can look into expanding into adjacent geographies, Japan, Southeast Asia, China from the, that kind of launchpad in South Korea. I would almost liken it to Sweden in that sense, what Sweden is to Europe, pretty small addressable market, but, you know, Spotify did all right.

ROSS BUTLER:

Absolutely. And so speaking of Europe, you’ve got some activity there too

VANIA SCHLOGEL:

Well. We’ve actually invested quite a bit in Europe. So we’re invested alongside KKR in a company called Neo nine studios, which is Germany’s largest production and distribution company in the country. I chair the board there were invested alongside EQT and epidemic sound, which is based in Stockholm. I also chair the board of that company. We just closed another investment alongside EQT in Malaga Spain, and a fantastic company called free pick.

ROSS BUTLER:

So under normal circumstances, your air miles are pretty significant,

VANIA SCHLOGEL:

Wonderful from the perspective of never having to pay for a personal vacation ever again. Yeah. I was spending a lot of time in Europe, I lived in London for six years. And so from a, from a sector perspective, I actually think it’s a wonderful geography to in, I think it’s multiples cheaper than a lot of us media.

ROSS BUTLER:

You’re relatively small funds to have a kind of what appears to be a completely global footprint and also personally global responsibilities, a portfolio of companies all over the place. And I guess that’s a function of being a sector specialist. Would you say

VANIA SCHLOGEL:

That’s exactly right. And I wouldn’t say we’re truly global because we genuinely as a operational fund, we have to spend time building relationships and liaising with folks. And so we’re very much present in Europe and Asia, we don’t touch geographies yet where we don’t have executives or very strong partnerships. So that would include, for example, South America Africa, those are geographies where we’re not present, but in Europe we feel very comfortable investing in the region you know, regulatorily regulatory perspective culturally even our role relationship Rolodexes, we feel very natural about investing in the region. And also importantly, we have such wonderful partners in terms of larger GPS that we work with as well as a lot of founders company founders that we know who also keep us connected on all the grounds.

ROSS BUTLER:

Well, I was going to come on to that because it’s very interesting, the fact that you you partner with some of the biggest buyer houses in the world on some of their deals. So they like you and they bring you in, they’ve got enough money of their own. What do they want from you?

VANIA SCHLOGEL:

That’s a great question. We feel a very strong duty towards our GP partners and today we’ve done, you know, we’ve, we’ve invested alongside KKR, EQT in TPG since the fund launched in 2017. And you’re absolutely right. We recognize very much that they have enough capital. They have a large committed funds and they certainly don’t need out water to come in to fill a hole. And hence there is a very strong expectation of performance on our side that in the Venn diagram of things not to get too nerdy, but they’re going to focus on, you know, these, these sets of operations. And we’re going to be over here focusing on our operational strategy and the two don’t really overlap. And that’s great that complimentarity of what we focus on and our expertise, I think is the reason why we get repeat business and repeat partnerships with these GPS.

VANIA SCHLOGEL:

And the other aspect is just we have a very, the way that we set up the operations of our fund are centered around our operational expertise. So I gave you one example, which is we’re present in South Korea because we understand it to be a trendsetter city in terms of content and technology trends, our LPs in South Korea. In fact, for example, Kakao is not only a partner of ours, but also an LP of ours. And if you imagine a digital media and technology group for a given country that owns the WhatsApp, Spotify, PayPal, Uber, and a few other assets of a country that is cacao, and they are one of our greatest partners in LPs. And so when we partner with the larger GP, we can actually go in as one of the only if not the only fund in the world that can say that and say, Hey, when, when this company, this portfolio company is looking to launch in Asia, we’re gonna consult and give a great body of expertise around having done this before. And Oh, by the way, we’ve got a fantastic digital media company there as an LP who now has a vested interest in making a success story.

ROSS BUTLER:

Yeah, that makes sense. So what, what specifically, what sub sectors, what types of creative companies are hot right now, interest you from an investment perspective?

VANIA SCHLOGEL:

We are very much focused on content and we focused on it from, from the inception and we built out a very strong investment thesis to the point where I almost feel sheepish saying content, because it’s such a broad umbrella term, the way that we segmented it is we got very deep into it. And so we’re looking for example, at content that is buoyed by the trend of online creator communities. We’re looking at content that has an over and exposure to growing over the top, or what’s called OTT streaming platforms like Netflix or Amazon. So while we spend a lot of time in content, we actually very delve down into those sub sectors that we feel have kind of acyclical component, but also from, from kind of a meta-thematic side being buoyed by digital trends and digitization, which COVID, by the way only helped to hasten quite frankly.

ROSS BUTLER:

Yeah. It’s interesting. Like when the, in the first internet, boom, like 20 years ago, everyone was constantly saying content is King, but looking back, I sometimes wonder whether actually for that first wave, but networks were King because the ones that did really well were the companies that capitalized on people’s people’s networks and kind of get the sense as you say, particularly with lockdown. And now that everyone’s got decent broadband and streaming services. And so on that the content might finally be having actually it’s it’s time in the sun. You’re gonna, when you think about that, like orthosis,

VANIA SCHLOGEL:

I’ve had this debate so many times about content versus distribution. And I think one of the most interesting case studies is what happened with Netflix. And I re you know, prior to launching house of cards in January of 2013 it was a pure play distribution platform, and I’ll never forget the production costs that were quite heavy for house of cards that Netflix had undertaken. If you actually have the interest and go back to a lot of the equity analysts and what they were saying about Netflix, it was brutal. I mean, it was just, this is daft, this is how many subscribers they would have to get to recoup this, and it just ripped them to shreds and what happens, they launched house of cards and in quick succession orange is a new black, the Marvel kind of TV series spinoffs, et cetera, and their stock price within the next year two and a half 10 next.

VANIA SCHLOGEL:

And, and so I think it’s I tell you that anecdote because where I land is that it seems more and more these days. It has to be the marriage both. Now, that being said I don’t know. I don’t mean that to say that there is not an opportunity for induction and content creators. I absolutely think that opportunity is there, but in, in order to really sell and continue selling in a systematic way and not be hit driven, these content creators need to focus on franchise defining or tentpole content to really have viable business models and also to try and own some of their intellectual. Are you going forward rather than just being a licensed, sor and working for fees in terms of the monetizing, their content? The other thing that I think is positive or content creators and intellectual property owners, is that pro in, in a, in a prior world, these content producers were selling into the traditional set of media buyers.

VANIA SCHLOGEL:

Then they were selling into the traditional set plus Netflix, and now the world has opened where now they’re selling into to Apple as well and other new entrance. And so it’s a great time to be a good content producer and intellectual property owner because the buyer set is proliferating. There’s just more and more buyers now of good and franchise defining content. I think one of the other things, and this is why we invested, for example, in Leonine is one. Yeah, the great things that happened from Netflix. And I actually mean this at associate level is because, so Netflix was able to aggregate eyeballs at a global level. There became this re-education process in the entertainment world that we are willing to watch local language, film, and TV, whether it’s the example of parasite, which is completely in Korean or dark, which is in German.

VANIA SCHLOGEL:

And so this put the emphasis and investment again in local language content. And I think that’s really important and social level. I don’t think we want to see a world where 98% of content is created and generated out of Hollywood and has an American perspective to it. I think we really want to honor diversity of content and also local traditions and cultures. And I think that’s one of the great not to go on a tangent, but it’s one of the wonderful things that actually has come from technological distribution is a refocus, any commercial case that now puts investment back again on local language content.

ROSS BUTLER:

I understand that a lot better now, because when you started speaking, I was going to say that all sounds great, but there’s, there’s only one Netflix, but I mean, Hey, that’s not quite true, but also it sounds like Netflix allows a whole ecosystem to happen as well in the same way, as, I guess, Amazon allows a whole ecosystem of suppliers to feed into it and get greater distribution. Yeah.

VANIA SCHLOGEL:

Yeah, absolutely. And I think to be fair, there need to any time one seeks a sustainability and health of an industry, there need to be countervailing forces. So while I’m also very positive on some of the positive things that Netflix has engendered why, why did we invest in Leo nine Leo nine took five companies and consolidated them into the number one player because scale at a local market level is a net necessary countervailing presence to a global technology player like Netflix. So I think for the health of the industry, also the, for the health of consumer choices going forward and for greater investment behind local content we as investors are placing our bets and trying to have scaled local players rather than just a fragmented market.

ROSS BUTLER:

Oh, these kind of film production companies, they, they are, they’re kind of like finance houses in themselves. Aren’t they, to some extent cause they’re then financing projects,

VANIA SCHLOGEL:

They are. Yeah. And that’s, that’s also why scale matters because content behaves very similarly to venture capital as an asset class, meaning you have a few real outliers in terms of performance and a lot of losses along the way. That is the nature of content that also scares a lot of investors. And so the way that we approach the sector is with eyes wide open and saying, we understand that’s how the asset class performs, but we also understand portfolio theory enough to know that diversification diversifies a way that unique hit risk. And so if a, an asset is scaled enough, it’s producing it. Number one, it’s producing enough new shows or films. And number two, it’s typically paired with an existing library that generates stable cash flows. And so I think there’s a perception versus reality gap. A lot of times when it comes to investors that investing in the content space, they just look at that unique project risk of it’s going to be great, or it’s going to be an absolute unmitigated disaster. We don’t view it that way. We view it as, as long as we can get into scaled ventures. A lot of that unique risk can be mitigated.

ROSS BUTLER:

Hmm. The fact that you’re partnering with big buyout firms also suggests that the risk profile isn’t that venturing. Yeah.

VANIA SCHLOGEL:

Yeah. That’s absolutely right. And, and Leonine, for example, spent the better part of two decades, for example buying up content and has eight, the best library in Germany. So as, as one example of why that’s so important when COVID hit and for a period in, in Germany productions completely shut down of new content, we were sitting on the country’s largest library. And so while we’re all hunkered down, bored out of our minds, looking for titles, and we’re going back to Tomb Raider and Home Alone and all those things that we watched in the past 20 years that library was generating fantastic cash flows for the company. And I think that’s a really good example of how an asset class that can be perceived as, so hit-driven actually ended up being one of the most sheltered and a cyclical assets as evidenced by what happened after COVID hit.

ROSS BUTLER:

Yeah. That’s amazing. Isn’t it? Do you want me, what’s your view of the future of private equity meeting, creative industries? Would it always be bore the specialist to some degree, or do you think there’s a larger opportunity opening up

VANIA SCHLOGEL:

Trend of a lot of pro previous operators within the media and entertainment space? Raising capital, for example, they’re, they’re doing a lot of fundless sponsor activity. I, I, you know, there are certain situations I can’t comment on now, but very well-known media executives who have identified proprietary deals as we talked about earlier and then going, and either partnering with private equity or with family offices, the rise of, of family offices, for example, has opened up a brand new and innovative kind of funding pocket. And, and they’re going about it that way. So it’s, again, it’s one of those industries that, and I mean, media and entertainment within private equity that is not only within it itself, but also the, the industries that are tangential to it. So media itself is constantly evolving, but also the way that private equity invest into media, it’s constantly open to evolution and sometimes outright tumbled. And so I do see that going forward, there’s going to be much more of a trend and continue trend of very well-known operators who have left their operating posts and want to try their hand at investing. And they’ll find funding, whether it’s through respect partnership. Spacs also, that’s part of the reason why there’s been such a rise in space.

ROSS BUTLER:

So is it because of the sector?

VANIA SCHLOGEL:

Exactly. Because who knows the media and entertainment sector better than, than folks who have a deep operating expertise within it. And so now they have creative ways of finding capital and because it lends itself to proprietary deal sourcing, I just think this industry is very unique relative to investing in other industries,

ROSS BUTLER:

Given that you’ve always been in investments and something’s doing creative, you’ve had quite a buried career cause you KKR, you’ve got your own shop. And in between you were a CIO ROC nation with, can you tell us a little bit about what Roc Nation is?

VANIA SCHLOGEL:

So rock nation is founded and helmed by Jay Z, who many people know. And, and one of the really interesting things about Jay, if you look at the history of his career. So yes, he is a very well known rapper and artist, but he’s also had a business savvy. So very early on, for example he structured the deal so that he the retention of his master rights reverted back to him, this is before artists were doing it at a broader scale. And I would say before Taylor Swift, for example, really got on that public messaging about it. And so he, he actually is, is a great example of someone who took his relationships and industry expertise and leverage that into an operational role by setting up rock nation. And so rock nation represents, I believe they started really in music now, they branched out to representing artists in outside of just music and then also athletes professional athletes and moving into those adjacent verticals and really what that comes down to is leveraging a Rolodex of relationships. And then having that credibility that, Hey, I care about your career, your art, I will be a good, good partner for you in a way that Jane the rock nation team can do.

ROSS BUTLER:

And, and culturally going from KKR to Roc Nation, and then to your own shop. I mean, they, they must be big leaps or was Roc Nation, very KKR-like?

VANIA SCHLOGEL:

Worlds apart. They are very, very different. And, and funnily enough, I would actually having experienced on the one, the Goldman Sachs and the KKRs and my career, and then on the other kind of the Roc Nation’s of the world I endeavored to set up the culture of Atwater to be a hybrid culture. So if you ever come to our offices, you know, you’ll see some funky art up, you know, music typically playing in the background. So it’s a little bit of a hybrid.

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